Question

Q1. The research department of ABC Limited has recently developed a new product which can be

manufactured using either of two methods. The costs involved under each of these methods are:

Method I: Plant with an estimated useful life of five years and a nil scrap value would be acquired for GH¢200,000. Fixed expenses (other than depreciation) would amount to GH¢60,000 per annum and variable costs per unit would be GH¢35.

Method II: Plant with an estimated useful life of five years and a nil scrap value would be acquired for GH¢80,000. Fixed expenses (other than depreciation) would amount to GH¢29,000 per annum and variable costs per unit would be GH¢45.

The product is to be marketed at GH¢60 per unit irrespective of the level of sales achieved. The maximum feasible production capacity under either method is 10,000 units.

Working capital requirements are GH¢40,000 under each method of production and the company depreciate plant on straight line basis.

Required:

a) Determine the number of units which must be produced and sold under either method each year in order to break even.   7 marks

b) Compute the number of units which must be produced and sold under either method each year in order to achieve a target return of 20% on capital invested. (Show workings). 8 marks

Answer 1

METHOD 1

Cost of plant = GH 200,000

Estimated life = 5 years

Scrap value = nil

Fixed expenses (Other than depreciation) = GH 60,000 per annum

Variable cost per unit = GH 35

Selling price per unit = GH 60

Working capital requirement = GH 40,000

Production capacity = 10,000 unts

Depreciation under straight line method = 200,000/5 = GH 40,000

Break even point (units) = Fixed cost / contribution per unit

Fixed cost = fixed annual expenses + Depreciation

=GH 60,000+GH 40,000

=GH 100,000

Contribution per unit = Selling price per unit - Variable cost per unit

= GH 60-GH 35

= GH 25.00

Break even point (units) = 100,000 / 25

= 4,000 units

Total capital invested = Fixed capital i.e. cost of plant + working capital

=GH 200,000 + GH 40,000

= GH 240,000

Desired profit = 20% of capital invested

= 20% of 240,000

= GH 48,000

Required volume of sales = Fixed cost + desired profit /Contribution margin per unit

Required volume of sales = 100,000 + 48,000 /25

= 148,000 /25

= 5920 units

METHOD II

Cost of plant = GH 80,000

Estimated life = 5 years

Scrap value = nil

Fixed expenses (Other than depreciation) = GH 29,000 per annum

Variable cost per unit = GH 45

Selling price per unit = GH 60

Working capital requirement =GH 40,000

Production capacity = 10,000 unts

Depreciation under straight line method = 80,000/5 = GH 16,000

Break even point (units) = Fixed cost / contribution per unit

Fixed cost = fixed annual expenses + Depreciation

= GH 29,000+GH 16,000

= GH 45,000

Contribution per unit = Selling price per unit - Variable cost per unit

=GH 60-GH 45

= GH 15.00

Break even point (units) = 45,000 / 15

= 3,000 units

Total capital invested = Fixed capital i.e. cost of plant + working capital

=GH 80,000 +GH 40,000

= GH 120,000

Desired profit = 20% of capital invested

= 20% of 120,000

= GH 24,000

Required volume of sales = Fixed cost + desired profit /Contribution margin per unit

Required volume of sales = 45,000 + 24,000 /15

= 69,000 /15

= 4600  units

THANK YOU !