Integrative Case 5-72 (Algo) Cost Estimation, CVP Analysis, and Decision Making (LO 5-4, 5, 9)

Luke Corporation produces a variety of products, each within their own division. Last year, the managers at Luke developed and began marketing a new chewing gum, Bubbs, to sell in vending machines. The product, which sells for $5.85 per case, has not had the market success that managers expected and the company is considering dropping Bubbs.

The product-line income statement for the past 12 months follows:

Revenue				$	14,700,150
Costs
Manufacturing costs	$	14,446,395
Allocated corporate costs (@5%)		735,008			15,181,403
Product-line margin				$	(481,253)
Allowance for tax (@20%)					96,250
Product-line profit (loss)				$	(385,003)

All products at Luke receive an allocation of corporate overhead costs, which is computed as 5 percent of product revenue. The 5 percent rate is computed based on the most recent years corporate cost as a percentage of revenue. Data on corporate costs and revenues for the past two years follow:

	Corporate Revenue		Corporate Overhead Costs
Most recent year	$	118,750,000	$	5,937,500
Previous year		77,400,000		4,982,315

Roy O. Andre, the product manager for Bubbs, is concerned about whether the product will be dropped by the company and has employed you as a financial consultant to help with some analysis. In addition to the information given, Mr. Andre provides you with the following data on product costs for Bubbs:

Month	Cases	Production Costs
1	219,000	$1,159,840
2	223,200	1,181,340
3	220,900	1,189,993
4	240,000	1,205,535
5	239,950	1,207,839
6	249,000	1,228,685
7	226,250	1,203,711
8	253,200	1,246,786
9	244,800	1,245,238
10	258,650	1,257,337
11	256,200	1,261,772
12	265,200	1,292,463

Required:

a. Bunk Stores has requested a quote for a special order of Bubbs. This order would not be subject to any corporate allocation (and would not affect corporate costs). What is the minimum price Mr. Andre can offer Bunk without reducing profit any further?

b. How many cases of Bubbs does Luke have to sell in order to break even on the product?

c. Suppose Luke has a requirement that all products have to earn 5 percent of sales (after tax and corporate allocations) or they will be dropped. How many cases of Bubbs does Mr. Andre need to sell to avoid seeing Bubbs dropped?

d. Assume all costs and prices will be the same in the next year. If Luke drops Bubbs, how much will Lukes profits increase or decrease? Assume that fixed production costs can be avoided if Bubbs is dropped.

Please explain the steps (Show formulas if using excel)