Question

Answer the following questions:

The launch of a new product is under consideration. Its unit variable costs will be £30 and it is estimated that incremental fixed costs of £250,000 will be incurred if production is commenced. Forecast sales are 50,000 units. If the actual planned selling price is £48 per unit, what will be the organisation’s margin of safety?

The following information is about two organisations, A and B.

	Organisation A	Organisation B
	£	£
Fixed costs	60,000	12,000
Variable costs per unit	0.20	0.50
Unit selling price	0.60	0.60
Expected sales levels (units)	160,000	160,000

Which firm has higher operating gearing?

Which firm is facing more risk in terms of its current sales predictions?

Be sure to demonstrate your numerical workings. Please explain where possible..

Answer 1

In the launch of new product

Break even sales=

Fixed costs

1-(variable cost /sales)

=250000

1-(30/48)

=$666666.67

Thus, margin of safety sales= Expected sales-breakeven sales

=$48*50000-$666666.67

=$1733333.33

Margin of safety ratio= margin of safety sales/total sales*100

=1733333.33 /2400000*100

=72.22%

Q2

Operating gearing =fixed costs/total costs*100

In firm A= 60000/(32000+60000)= 0.65

In firm B=12000/(80000+12000)=0.13

Firm A has higher operating gearing.

In terms of facing more risk in current sale prediction, it can be predicted by calculating break even point

Break even point = Fixed cost /contribution per unit

A=60000/0.40= 150000 units

B= 12000/0.10=120000 units

It is evident that the firm A is more risky as break even point is achieved at 150000 units whereas total sales expected is 160000 units. Later the breakeven point is achieved, less profitable /beneficial it is.

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