Using the steps in Clement Ojugos article, Knowing your break-even point critical to good decision making, solve the following: You are opening a new retail shop and estimated fixed costs for the vacant facility are $7,500 per month. Estimate that items will sell for approximately $30 each, the combined variable cost of product and labor are estimated at $10 with a selling price of $30. You feel certain that the market for this new retail shop is 100 transactions per day. Determine if you should open the retail shop in this vacant space. Include the break-even transactions, CM%, and the break-even dollar amount. Explain your answer (include rationale if your answer is yes or no).

Clement Ojugos article, Knowing your break-even point critical to good decision making,

Knowing the relationship among cost, volume and profit, or CVP, is your most powerful tool in making better decisions. It will show you:

* the volume of sales required to break even and generate profit,

* the proper menu pricing in relation to cost of sales,

* the impact of product sales mix on product contribution,

* and whether to open or close an operation.

The following scenario will help you understand CVP relationships.

Assume, due to the recession, you closed a restaurant or profit center within your hotel, and all leading periodicals have declared that the recession is over. The situation now requires you to consider whether to reopen your restaurant.

Given the above scenario, some restaurants will wait too long to be assured of at least breaking even, because they will calculate their "full costs" should they reopen. Undue delay will extend the agony of laid-off employees and cause the loss of market share as the recovery proceeds. Rushing to reopen and book new business at prices that might fail to cover the variable costs of operation can do further damage to the financial health of the business. The middle ground is to reopen at the marginal contribution break-even point, or MCB, where the incremental revenues that can be generated by reopening equal or exceed the direct and indirect costs of reopening.

The important thing to remember is to avoid using full-cost accounting to make your decision. The decision should be based on how costs and revenues actually behave in response to a change in variables of the business, such as volume, price or product mix. Enlightened executives realize "sunk costs" are those that already have been incurred and cannot be changed by any decision made now or later, so they must be ignored when making this determination.

To illustrate the principle of sunk costs, assume that a restaurant paid $10,000 for pizza equipment some years before the recession. The equipment was used to make a pizza that is no longer being sold. While the purchase in hind- sight seems wasteful, the $10,000 cost has been incurred and cannot be undone. It would be unwise to continue making the obsolete product in a misguided attempt to recover the original cost of the equipment. In short, the $10,000 originally paid for the equipment is a sunk cost that should be ignored in decision-making.

The examples below will illustrate ways in which MCB analysis can be applied to help make a sound decision in difficult economic times. MCB is not a cure-all, but it is an important tool for proper decision-making.

In the described scenario, suppose the restaurant has kitchen equipment sufficient to operate a new steakhouse. Estimated fixed costs for this vacant facility are $5,000 per month. Now it is your task to determine the probability of opening a steakhouse using this equipment. Estimating that menu items will sell for approximately $25 each, the combined variable cost of product and labor are estimated at $8 with a selling price of $25. You feel certain that the market for this steakhouse is 400 covers per day, or about two-thirds of the physical capacity of the vacant space of 600 covers per day.

Our simple MCB analysis will determine whether we should open the steakhouse in this vacant space. To begin to answer this question, we need to find the contribution margin, or CM, for the steakhouse menu. CM is simply what's left of revenue to cover fixed costs and profit after variable costs have been subtracted. The equation is as follows: CM = revenue - variable cost, or VC

When you subtract fixed costs, or FC, from the CM, you get gross profit or income before taxes. You can then calculate your break-even level by dividing fixed costs by the CM. The CM can be based on a per cover basis or as a percentage of sales. Therefore if you express CM on a per-cover basis, break-even volume will be expressed in covers, and if expressed as a percentage of sales, break-even volume will be in dollars. The accompanying chart provides the calculations for evaluating the steakhouse project.

Note that you can get the break-even dollar total by multiplying the break-even volume in covers by the selling price, or you can get the number of covers by dividing total break-even revenue dollars by price.

Based on the assumptions of our scenario, the simple answer to the question of whether "to open or not to open" is "to open." Why? To break even one need only to do about 294 covers per day, or 73.5 percent of the projected market of 400 covers per day. Of course, an operator needs to be sure the projected market is not wishful thinking. Note that at break even, one will be operating well under the restaurant's physical capacity of 600 covers per day. Therefore profitability will result when the restaurant captures more than 73.5 percent of the projected business. With production and sales at full capacity, the steakhouse should make a handsome profit of $7,650 per day before taxes - 306 covers x $25 = $7,650.