Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. Use the formula method to determine the sales dollars that must be generated to attain target profits of $2,500 per month.
a. $2,550
b. $5,013
c. $8,456
d. $10,555
The Correct Answer and Explanation is :
To calculate the sales dollars needed to achieve the target profit, we use the formula:
[
\text{Sales Dollars} = \frac{\text{Fixed Expenses} + \text{Target Profit}}{\text{Contribution Margin Ratio}}
]
Step 1: Calculate the Contribution Margin per Unit
[
\text{Contribution Margin per Unit} = \text{Selling Price per Unit} – \text{Variable Expense per Unit}
]
[
\text{Contribution Margin per Unit} = 1.49 – 0.36 = 1.13
]
Step 2: Calculate the Contribution Margin Ratio
[
\text{Contribution Margin Ratio} = \frac{\text{Contribution Margin per Unit}}{\text{Selling Price per Unit}}
]
[
\text{Contribution Margin Ratio} = \frac{1.13}{1.49} \approx 0.758
]
Step 3: Use the Formula to Calculate Sales Dollars
[
\text{Sales Dollars} = \frac{\text{Fixed Expenses} + \text{Target Profit}}{\text{Contribution Margin Ratio}}
]
[
\text{Sales Dollars} = \frac{1,300 + 2,500}{0.758} = \frac{3,800}{0.758} \approx 5,013
]
Final Answer:
The sales dollars that must be generated to attain a target profit of $2,500 per month is b. $5,013.
Explanation (300 Words)
This problem involves determining the sales revenue required to achieve a specific profit using cost-volume-profit (CVP) analysis. The key concept here is the contribution margin, which represents the amount remaining from sales revenue after variable costs are covered. This amount contributes to fixed costs and profit.
We first calculate the contribution margin per unit by subtracting the variable expense ($0.36) from the selling price ($1.49), resulting in $1.13 per cup. Next, the contribution margin ratio is derived by dividing the contribution margin per unit by the selling price, yielding approximately 0.758 or 75.8%. This ratio indicates that 75.8% of every sales dollar contributes to covering fixed expenses and generating profit.
Using the formula, we add the fixed expenses ($1,300) and the target profit ($2,500) to get the total amount needed to cover both. Dividing this sum ($3,800) by the contribution margin ratio (0.758) gives the required sales revenue, approximately $5,013.
This method is crucial for business planning, as it allows companies like Coffee Klatch to set realistic sales targets, manage costs, and ensure profitability.