Peggy Grear just fulfilled a dream as she completed her first season as the owner of a rafting company. Unfortunately, her operation was not profitable. She has had enough savings to get her through another season or two, but she realizes that she will have to start making a profit or give up her dream. Her company’s income statement for the first year of operation follows.
Grear Rafting Company
For the Year Ended December 31, 2003
Rental Cost of Rafts and Camping Equipment (208,600)
Meals Provided to Rafters (314,400)
Advertising Expenses (50,000)
Compensation Paid to Guides (471,600)
Salary of Office Manager (16,500)
T-shirts and Hats Provided to Rafters (31,440)
Office Utility Expense (3,850)
Net Income (Loss) $ (48,390)
Additional Information: Equipment is rented on an annual basis. Additional equipment is not available, nor is an allowance provided for early returns. Guides are paid on a commission basis. Ms.Grear’s company served 1,048 rafters during the year.
a. Identify the fixed and variable costs relative to the number of rafters.
b. Reconstruct the income statement using the contribution-margin approach.
c. How many rafters are required for Ms. Grear to earn a $50,000 profit?
d. In discussions with her accountant, Ms. Grear was told to expect a 10 percent increase in fixed cost during the following year. She responded with this question, “If these costs are fixed, why are they going to increase?” Assume that you are the accountant; respond to Ms. Grear’s question.
e. In addition to the expected increase in fixed cost, the accountant told Ms. Grear to plan for a 20 percent increase in variable cost. On the basis of these increases, how many rafters would be required to earn the $50,000 desired profit if the price per rafter remains the same?
f. Assume that Ms. Grear believes that it is unlikely that she will be able to attract the number of rafters identified in Part e. Explain how sensitivity analysis could be used to investigate how to attain a $50,000 profit.