Question

Question 1

Ruby Limited manufactures and sells desks. Price and cost data for the company are provided below:

Selling price per unit                                                                        $250

Variable costs per unit

Manufacturing

Direct materials                                                          $82

Direct labour                                                               $40

Variable manufacturing overhead                            $60

                                            Variable selling and administrative costs                            $16

Fixed manufacturing overhead $1,440,000 Fixed selling and administrative costs $2,070,000 Forecasted annual sales $17,500,000

                    Annual fixed costs

Ruby Limited pays income taxes of 30 percent.

Required:

1. What is Ruby Limited’s break‐even point in units?

2. How many units would Ruby Limited have to sell in order to earn a profit of

$1,820,000 after tax?

3. If the company’s direct labour costs increase by 10 percent, how many units will the company have to sell next year to reach its break‐even point?

4. Ruby Limited manufactures chairs using a completely automated production process. Its major competitor, Emerald Industries, assembles its products manually. How will these two companies’ cost structures differ? What is operating leverage factor? Which company will have a higher operating leverage factor? Explain.

5. How can a company with multiple products compute its break‐even point?

(5 + 3 + 4 + 6 + 4 = 22 marks)

Answer 1

(a) Break Even Point (units) = Fixed Cost / Contribution per Unit

Fixed Cost = Fixed manufacturing overhead + Fixed selling and administrative costs

=  $1,440,000 + $2,070,000 = $3,510,000

Contribution Per Unit = Selling Price - Variable Cost per unit

= Selling Price - (Direct Materials +Direct Labor + Variable Over Head+Variable selling and administrative cost)

= 250 - (82+40+60+16) = 250 - 198 = 52

Break Even Point (Units) = $3,510,000 / 52 = 67,500 UNITS

(b) Units would Ruby Limited have to sell in order to earn a profit of

$1,820,000 after tax

Sales to earn desired profit =(Fixed cost + Desired Profit ) / PV ratio

Desired Profit before tax = 1820,000 * 100/70 ( back working to get before tax profit)

= 2600,000

PV RATIO = Contribution / Sales = 52/250 = 20.8%

Sales to earn desired profit = ( $3,510,000 + $ 2600,000 ) / 0.208

$ 250 * Units to be sold = 6,110,000/ 0.208

$ 250 * Units to be sold = $ 29,375,000

Units to be sold = $ 29,375,000 /  $ 250

Units to be sold = 117,500 units

(c) When Direct labor increase by 10% new break even point,

Break Even Point (units) = Fixed Cost / Contribution per Unit

Fixed Cost = $3,510,000

Direct labour increase by 10 % = 40 + 10% of 40 = $ 44

Contribution Per Unit = Selling Price - Variable Cost per unit

= Selling Price - (Direct Materials +Direct Labor + Variable Over Head +Variable selling and administrative cost)

= 250 - (82+44+60+16) = 250 - 202= 48

Break Even Point (Units) = $3,510,000 / 48 = 73,125 UNITS

(d)  

Since Ruby limited uses fully automated production process, the cost structure is very much different . IN ruby the cost includes less labor cost , more Electricity cost, repair cost of machines, more depreciation cost etc

Where as in Emerald cost includes more labor cost, less depreciation cost, less repair costs etc fixed costs will be less compared to Ruby

Wastage of materials will be less in Ruby

Operating leverage factor are the Fixed costs that effect the level of profit

In Ruby the Fixed costs will be high than emerald because in an automated environment , the depreciation costs, interest costs and other fixed costs on machines will be high.

Ruby will have higher Operating leverage factor as it it is technological oriented company