Part A For Problems 110 Consider the Baseline simplified in

Part A - For Problems 1-10 Consider the Baseline simplified income statement displayed below, where it is assumed that purchases and other expenses account for, respectively, 50% and 40% of sales:

Baseline

Sales                                                             $1,000

Cost of goods sold

      Purchases (50% of sales)          $500

      Other expenses (40% of sales) $400       $ 900

Profit before taxes                                       $ 100

(10 Points) For problems #1-5, prepare a modified income statement to show that the sales must be increased by 10% in order to increase the before-taxes profit by 10%.

Increase Sales by 10%

Sales                                                                $ #1

Cost of goods sold                                            

      Purchases (50% of sales)        $ #2  

      Other expenses (40% of sales) $ #3          $ #4

Profit before taxes                                         $ #5

(10 Points) For Problems 6-10, prepare another modified income statement to show that, through the profit leverage, a 2% reduction in the purchasing costs of $500 will have the same impact on the before-taxes profit as the aforementioned 10% increase in sales.

Reduce Purchases by 2%

Sales                                                                $ #6

Cost of goods sold                                            

      Purchases (48% of sales)          $ #7  

      Other expenses (40% of sales) $ #8          $ #9

Profit before taxes                                       $ #10

Solution

Scenario : Increase sales by 10% :

Revised sales value = $1000 x 1.10 = $ 1100

Purchase ( as 50% of sales ) = 0.50 x 1100 = $550

Other expenses ( as 40% of sales ) = 0.40 x 1100 = $440

Thus, Profit before tax = Sales – Purchase – Other expenses = $1100 - $550 - $440 = $110

Scenario : Reduce purchase by 2%

Sales value = $1000

Purchase ( reduce 2% from original value of $500 ) = $500 x 0.98 = $490

Other expenses ( 40% of sales ) = $400

Thus, Profit before tax = Sales – Purchase – Other expenses = $1000 - $490 _ $400 = $110