Case Facts: Firm sells 3 products A, B and C with demand of A expected to fall, that of B to remain stable and that of C to double Fixed costs in the plant change with capacity of utilization Half of the profit after taxes are shared with the government The selling price of C to be increased to reflect quality and maintain reputation
Changes Expected: Capacity to be increased by investment of $60,000 per month (720,000 per year) Sale price to C is to be increased by 100% Sales volume of C is to be increase by 450000 units o Sales volume of A is reduced to 2/3 to 400000 units
Assumptions implicit in Bill Frenchs determination of his companys break-even point: Assumed that Duo-Products' relevant range for fixed costs will remain constant even after planned expansion of production capacity. Assumed there is just one breakeven point for the firm (by taking the average of the 3 products). Assumed that the sales mix will remain constant. Total revenue and total expenses behave in a linear manner over the relevant range.
On the basis of Frenchs revised information, what is a break-even point? Breakeven number of units = Fixed costs / Contribution margin per unit Contribution margin per unit = Selling price Variable cost per unit
Aggregate Sales at Full capacity (Units) New Sales Volume (Units) Sales price per unit($) Revenue (Total)($) Variable Cost /Unit($) Contribution Margin per Unit($) Total Variable Costs($) Fixed Costs($) Profit($) 2000000 1750000 6.948 12160000 3.385 3.56 5925000 3690000 2545000
Ratios: Variable Cost to Sales Unit Contribution to Sales Utilization of Capacity Break-Even point (Units)
The break even unit for the aggregate production is 1035686 units. For Extra dividend, ignoring union demands: To pay the extra dividend of 50% and to retain the profit of $150000, we need to have the profit after taxes as $600000. As half of the revenues go to the government as taxes therefore the total revenues before tax deduction should be equal to $1200000.
Selling price Variable cost per unit Contribution margin per unit Operating income before tax(assuming 50% of the revenue goes as tax to the government) Total Fixed Cost No of units required to be produced= (FC + Operating income)/Contribution
Selling price Variable cost per unit Contribution margin per unit Operating income before tax(assuming 50% of the revenue goes as tax to the government) Total Fixed Cost No of units required to be produced= (FC + Operating income)/Contribution
Level of operations that must be achieved to meet both union demands & bonus dividends: Operating income after taxes($450000 dividend + $150000profits)
Contribution margin per unit Operating income before tax(assuming 50% of the revenue goes as tax to the government) Total Fixed Cost No of units required to be produced= (FC + Operating income)/Contribution
Can the break-even analysis help the company decide whether to alter the existing product emphasis? What can the company afford to invest for additional C capacity? Break even analysis can be used to decide whether to alter the existing product emphasis or not. For example in this case, if we refer last years data, we can see that the product C is not economically feasible to manufacture at $2.40 /unit. Following table gives the analysis for checking whether the company can afford to invest in additional C capacity.
Sale price Sale revenue Variable Cost Total Variable Cost Contribution Fixed Cost Investment the company can afford
Calculate each of the three products break even points using the data. Why is the sum of these three volumes not equal to the 1,100,000 units aggregate break-even volume?
Aggregate Sales at Full capacity (Units) Sales Volume (Units) Unit Sales price($) Sales Revenue($) Variable Cost/Unit ($) Contribution Margin/Unit($) Total Variable Costs ($) Fixed Costs($) Profit Ratios: Variable Cost to Sales Unit Contribution to Sales Utilization of Capacity Break-Even point (Units) 2000000 1500000 7.2 10800000 4.5 2.7 6750000 2970000 1080000
Break-even analysis is a basic tool that can be used to determine the level of sales that is required for the company to start earning a profit. Helps understand and formulate the relationship between costs (fixed and variable), output and profit Helps observe profit levels at different outputs. In a wide product range, the analysis helps to find out which products are performing well and which are leading to losses. Can be used to set sales targets and/or prices to generate target profits