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Mia Violetta, after graduating from university took a one week vacation on Hawaii. Starting from the spiritual beauty of the hula, over the emerald valleys, and golden sands to the visceral power of an active volcano, Hawaii can be called the most magnificent place on Earth. During her time on Hawaii, she started thinking about opening up her own business here. She noticed that people on the beach are always dirking something, as the weather is tropically warm throughout the year. While return home from her vacation she started thinking about opening up a milkshake stand on the beach of a resort in Hawaii.
She studied the existing restaurants, read industry reports, and did some research on expected minimum costs to be incurred in operating the business. A unique feature of her milkshake is that she will serve them with flavored straws that match the flavor of the chosen milkshakes by customers. Mia’s research embeds the following assumptions:
Sales prices of per cup of milkshake $7.00.
Cost of materials needed to make milkshakes:
Direct material ingredients 1 cup of milkshake (8 oz. size)
Whole Milk ($15 for a 5 gallon=740 oz.) (need 2 oz. of milk)
Cream ($20 for 1 gallon=128 oz.) (need 2 oz. of cream)
Sugar ($10 for a 15 lb. bag=30 cups) (need ½ cup of sugar)
Premium Vanilla Ice Cream ($24 for 600 oz.) (need 6 oz.)
Flavorings .25 per shake
Flavored specialty straws .75 per straw
Cups (500 8 oz. cups @ a cost of $200)
• Milkshake stand rental $500 a month
• Cleaning and other miscellaneous supplies $100 a month
• Equipment: Industrial Milk Shake Maker: $72 per machine x 10 machines=$720
• Equipment: Industrial Refrigerator/freezer: $480
• Countertops: $1,200
• Tables and benches for customers to sit outside: $108 per bench-set x 10=$1,080
• Annual insurance: $600 a year
The milkshake makers, tables and benches are assumed to last for 3 years. The refrigerator/freezer and counter tops are assumed to last for 10 years.
Mia is going to take out a loan of $4780. A self amortizing loan is assumed to be obtained from a bank, and carries an annual interest rate of 6% payable over 2 years with monthly payments (each monthly payment consists of both principal and interest).
Two part-time employees: with each receiving a monthly salary of $800 per month (including taxes and benefits).
REQUIREMENTS OF THE CASE
1) Calculate the monthly fixed of running this milkshake stand.
2) Calculate the per unit variable cost.
3) Using the above information, determine the number of milkshakes you will need to sell to break even. In order to do this, you will need to classify the above costs into fixed or variable.
(Hint: keep all costs on monthly basis throughout your analysis).
4) Now consider that the owner will take fixed monthly salary of $1,000.
Calculate the new fixed cost per month of the company and determine the amount of milkshakes you will need to sell to break even.
5) Mia has set her goal to sell 800 units in the first month of operation. Calculate the margin of safety of this business. Explain what you understand by margin of safety and interpret the result you’ve obtained.
6) Consider the following information. Construct two income statements using bothvariable costing and absorption costing.
Beginning units 50 150
Units produced 900 800
Units sold 800 700
Ending inventory 150 250
7) Reconcile the NOI calculated under variable costing and absorption costing, for the month of May and June.
8) If units produced exceeds units sold, which method (variable costing/ absorption costing) would you expect to show the higher NOI? Why?