Question

nswer the following questions:

1. 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. At what level of price for the new product will the organisation break even? If the actual planned selling price is £48 per unit, what will be the organisation’s margin of safety?
   
2. 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?
• What is the expected net income of both firms?
• What would expected net income be for both firms if sales were a) 140,000 units and b) 180,000 units?
• Which firm is facing more risk in terms of its current sales predictions?

Be sure to demonstrate your numerical workings.

Answer 1

Break even price will be

Contribution =Fixed costs

250000= contribution p.u *50000

Contribution p.u= $5

Variable costs p.u=$ 30

Thus break even price for new product is =$35

At $48, break even sales are:

$666666.67

MARGIN OF SAFETY SALES ARE :

Expected sales - break even sales

=$1733333.33

Operiating gearing ratio =Fixed costs /total costs

Firm A=60000/(60000+32000)=0.65

Firm B= 12000/92000=0.13

Firm A has higher operating gearing ratio

A) if sales are140000 units

Firm A:

Total contribution =140000*0.40=$56000

Less fixed costs=$60000

Loss=$4000

Firm B:

Total contribution =140000*0.10=$14000

Less fixed costs: 12000

Profit: $2000

B) If sales are 180000 units

Firm A

Total contribution : 180000*0.40=$72000

Less:fixed costs:$60000

Profit: $12000

Firm B

Total contribution: 180000*0.10=$18000

Less fixed costs : $12000

Profit:$6000

In terms of current sales predictions firm A is more risky as leverage ratio is higher is firm A.

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