Question

Newlights makes decorative lightbulbs for festivals. The firm’s fixed costs amount to RM4,500 per month. The materials for each lightbulb are imported and cost RM31 per lightbulb. Only part-time workers, who work for hourly rates, are employed to assemble these lights. These part-time workers are paid RM28 per hour, and each light takes 30 minutes to assemble. The lightbulbs are sold to retail outlets for RM90 each. Newlights sells 150 lightbulbs each month.

Required:

1. Calculate the breakeven point (in units sold and total sales).

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2. Find the margin of safety.

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3. Newlight wishes to shift to a new location that offers sophisticated automation options. The fixed costs will increase to RM6,000 per month. However, the new location provides opportunities to automate the assembly line, as such, each part-time employee is able to assemble four light bulbs per hour. The material costs per lightbulb remain unchanged. Compute the new breakeven point in units and sales. Should Newlights shift to this new location? Justify your answer.

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4. Mark Spender, a production engineer at Newlights, has an interesting perspective. He opines that Newlights should just focus on maximising production. He also mentions that since fixed costs, such as factory rent, would be spread over more units, this strategy would lead to lower costs per unit and reduce the number of units required to breakeven. Do you agree with Mark’s idea that maximising production will lower the breakeven point? You must justify your stance.

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(6 + 2 + 4 + 4 = 16 marks)

Answer 1

Fixed costs RM4,500 per month.

Materials RM31 per lightbulb

Wages RM28 per hour, and each light takes 30 minutes to assemble, therefore wages payable per lightbulb is RM14 (RM28/2).

Selling Price RM90 each

Income Statement (150 lightbulbs)

Particulars	Per unit (in RM)	Amount (in RM)
Sales	90	13,500
Less: Variable Cost
Material	31	4,650
Wages	14	2,100
Contribution	45	6,750
Less: Fixed Cost		4,500
Profit		2,250

a. Breakeven point (in units sold and total sales):

It is a point where neither profits nor losses have been made is known as a break even point. this implies that in order to break even the amount of contribution the amount of contribution generated should be exactly equal to the fixed costs incurred.

Break even point in units = Fixed Costs/ Contribution per unit

while substituting,

RM4,500 / RM45 = 100units

Breakeven point in total sales = Fixed Cost / PV Ratio

PV Ratio = (Contribution / Sales) * 100

= RM6,750 / RM13,500

=50%

Breakeven point in total sales = RM4,500 / 50%

= RM9,000.

a. Margin of Safety:

Margin of safety = Actual or Projected Sales - Break even sales (or)

Profit / PV Ratio

While substituting,

Sales = RM13,500

Break even sales = RM9,000

Margin of safety = RM13,500 -  RM9,000

= RM4,500.

a. Profitability of Newlights shift at new location:

Fixed costs = RM6,000 per month

Wages (four light bulbs per hour) = RM28/4 = RM7

Material costs per lightbulb = RM31

Income Statement (150 lightbulbs)

Particulars	Per unit (in RM)	Amount (in RM)
Sales	90	13,500
Less: Variable Cost
Material	31	4,650
Wages	7	1,050
Contribution	52	7,800
Less: Fixed Cost		6,000
Profit		1,800

a. Breakeven point (in units sold and total sales):

Break even point in units = Fixed Costs/ Contribution per unit

while substituting,

RM6,000 / RM52 = 115units (approximately)

Breakeven point in total sales = Fixed Cost / PV Ratio

PV Ratio = (Contribution / Sales) * 100

= RM7,800 / RM13,500

=57.77% or 58% (approximately)

Breakeven point in total sales = RM6,000 / 58%

= RM10,345 (approximately)

a. Margin of Safety:

Margin of safety = Actual or Projected Sales - Break even sales (or)

Profit / PV Ratio

While substituting,

Sales = RM13,500

Break even sales = RM10,345

Margin of safety = RM13,500 -  RM10,345

= RM3,155.

Since the profit is comparitively less in new location, Newlights should not shift to this new location.

a. Mark Spender, a production engineer at Newlights, opines that Newlights should just focus on maximising production. He also mentions that since fixed costs, such as factory rent, would be spread over more units, this strategy would lead to lower costs per unit and reduce the number of units required to breakeven.

I am not agreeing with Mark’s idea that maximising production will lower the breakeven point because It is a point where neither profits nor losses have been made is known as a break even point. this implies that in order to break even the amount of contribution the amount of contribution generated should be exactly equal to the fixed costs incurred.

The word contribution has been given its name because of the fact that it literally contributes towards the recovery of fixed costs and making of profits. The contribution grows along with the sales revenue till the time it just covers the fixed cost.Hence, if we know how much contribution is generated from each unit sold we shall have sufficient information for computing the number of units to be sold in order to break even.

Therefore inorder to change break even sales one should try to increase contribution per unit or to decrease fixed cost, as these two factors influence the break even point the most.

Increasing contribution per unit can be achieved through increasing selling price or decreasing variable cost.

Therefore in my opinion just focusing on maximising production will not reduce the number of units required to breakeven. In order to reduce the number of units required to breakeven we should give true care in reducing variable costs and fixed costs.