Question

Case 1 Cost-Volume-Profit (CVP) analysis + marginal analysis

You are the manager in Bright company that produces paper bags for food shops and supermarkets. You are provided with following information:

• Bright company is able to produce 60,000 packs of bags.
• Its current sale volume is 50,000 packs of bags per year. This has achieved its maximum sale force.
• Current selling price is $10 per pack of bags.
• Variable costs in total are $200,000;
• Fixed costs are $ 125,000.

A newly established shop has approached you, informing a willingness of purchasing 5,000 packs of bags per year at a price of $6 for each bag. If this proposal is accepted, unit variable costs would remain the same however fixed costs would increase by $6,000 per year.

Required:

1. Discuss whether this proposal is worthwhile from a financial point of view.

2. Analyze, if your competitor in the paper industry knows the above cost and price information, what action(s) may the competitor take to beat you in the market.

Answer 1

proposal of newly established shop

Particulars	units (1)	per unit (2)	total[(1)*(2)]
sales	5000	6	30,000
less: variable cost	5000	4(200000/50000)	20,000
contribution	5000	2	10,000
less: fixed cost	5000	1.2(6000/5000)	6,000(as given)
net income	5000	0.8	4,000

as per the given information, the maximum capacity of production is 60,000 units and the maximum sale force is 50,000 units excluding the newly established shop's proposal. and the net income that can be received by accepting the proposal would be $4,000 as calculated above. even though the margin is considerably low when compared with the original net income that is earned by selling 50,000, it is preferable to accept the proposal as the bright company can utilize its production capacity.

if the above cost and price information is known to a competitor in the paper industry, he might try to reduce the variable cost per unit there by increasing the net income, and the competitor might also try to provide discount in the selling price in order to attract the customer and to gain the market..