Question

Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 81,000 units for $65 per unit. The variable production costs are $35, and fixed costs amount to $1,410,000. Production engineers have advised management that they expect unit labor costs to rise by 15 percent and unit materials costs to rise by 10 percent in the coming year. Of the $35 variable costs, 40 percent are from labor and 20 percent are from materials. Variable overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 5 percent as a result of increased taxes and other miscellaneous fixed charges.

The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 7 percent during the year.

Required:

a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for "Volume in units" to the nearest whole number and round your answer for "Sales" to the nearest whole dollar amount.)

b. Compute the volume of sales in units and the dollar sales level necessary to provide the 7 percent increase in profits, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for "Volume in units" to the nearest whole number and round your answer for "Sales" to the nearest whole dollar amount.)

c. If the volume of sales were to remain at 81,000 units, what price change would be required to attain the 7 percent increase in profits? Calculate the new price. (Round intermediate calculations of unit cost and final answer to 2 decimal places.)

Answer 1

Solution:

First of all we need to find out the present variable cost.

WE need to bifurcate the variable cost into labor, material and overhead.

	Present (81,000 Units)
	$ per unit	Total
Sales Revenue	$65.00	$5,265,000
Variable Cost
Variable Labor Cost ($35*40%)	$14.00	$1,134,000
Variable Material Cost ($35*20%)	$7.00	$567,000
Variable Overhead ($35*40%)	$14.00	$1,134,000
Total Variable Cost	$35.00	$2,835,000
Contribution Margin	$30.00	$2,430,000
Fixed Costs		$1,410,000
Profit		$1,020,000

In coming year, there is an expected increase in labor, material and overhead variable cost and selling price

	Coming Year
	$ per unit
Sales Revenue ($65 + 10% increase)	$71.50
Variable Cost
Variable Labor Cost ($14+15% increase)	$16.10
Variable Material Cost ($7 + 10% increase)	$7.70
Variable Overhead ($14 + 20% increase)	$16.80
Total Variable Cost	$40.60
Contribution Margin	$30.90
Fixed Costs (1,410,000+5% increase)	$1,480,500

Coming Year Contribution Margin Ratio = Contribution Margin $30.90 / Sales $71.50 x 100 = 43.21678%

Part a –

Volume in units necessary to maintain the present profit level = (Fixed Cost + Present Profit) / Contribution Margin Per unit

= ($1,480,500 + $1,020,000) / 30.90

= 80,922.33 Units

Volume in dollar sales necessary to maintain the present profit level = (Fixed Cost + Present Profit) / CM Ratio

= ($1,480,500 + $1,020,000) / 43.216783%

= $5,785,947

Part b –

7% increase in profit = Present Profit $1,020,000 + 7% increase = $1,091,400

volume of sales in necessary to provide the 7 percent increase in profits= (Fixed Cost + Desired Profit) / Contribution Margin Per unit

= ($1,480,500 + $1,091,400) / 30.90

= 83,233 Units

volume of the dollar sales level necessary to provide the 7 percent increase in profits = (Fixed Cost + Desired Profit) / CM Ratio

= ($1,480,500 + $1,091,400) / 43.216783%

= $5,951,160

Part c -- If the volume of sales were to remain at 81,000 units, what price change would be required to attain the 7 percent increase in profits? Calculate the new price

Assumed that the scheme is implemented for coming year

Let assume New Selling Price = P

Contribution Margin = New Selling Price – Variable Cost $40.60

Required Contribution Margin = Fixed Cost $1,480,500 + Desired Profit $1,091,400 = $2,571,900

(New Selling Price – Variable Cost $40.60) * 81,000 Units = $2,571,900

New Selling Price – VC $40.60 = $2,571,900 / 81,000 = $31.75

New Selling Price = $31.75 + VC $40.60

New Selling Price = $72.35

Assumed that the Scheme is not implemented Coming Year

Contribution Margin = (New Selling Price - Variable Cost $35) * 81,000 Units

Required Contribution Margin = Fixed Cost $1,410,000 + Desired Profit $1,020,000*7% = $2,501,400

(New Selling Price - Variable Cost $35) * 81,000 Units = $2,501,400

New Selling Price = $65.88

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