Question

Break-Even in Units, After-Tax Target Income, CVP Assumptions

Campbell Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Campbell developed its business plan for the year based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $120,000. Campbell’s after-tax profit objective was $216,000; the company’s effective tax rate is 40 percent.

While Campbell’s sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the after-tax profit projection for the year would not be reached unless some actions were taken. Campbell’s president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president:

A. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast.

B. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted.

C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.

Required:

1. Determine the number of units that Campbell Company must sell in order to break even assuming no changes are made to the selling price and cost structure.
units

2. Determine the number of units that Campbell Company must sell in order to achieve its after-tax profit objective.
units

3. Determine which one of the alternatives Campbell Company should select to achieve its annual after-tax profit objective.

Be sure to support your selection with appropriate calculations.

	After-tax profit
Alternative A	$
Alternative B	$
Alternative C	$

Answer 1

1.Number of units that Campbell Company must sell in order to break even assuming no changes are made to the selling price and cost structure:

Particulars	Amount
Sales Price per unit(A)	$400
Less: Variable cost per unit (B)	$(200)
Contribution per unit (A-B)	$200
Fixed cost	$120,000

> Break-even point in no.of units = Fixed Cost/Contribution per unit

=120000/200

=600 units

2.The number of units that Campbell Company must sell in order to achieve its after-tax profit objective:

Particulars	Amount
Desired after-tax profit	$216,000
Tax rate	40%
Profit before tax = 216000*100/60 (A)	$360,000
Add: Fixed Cost (B)	$120,000
Required Contribution (A+B)	$480,000

> No.of units to be sold to achieve desired profit =

= 480,000/200

= 2400 units

3. Alternative A:

Particulars	Alternative A	Alternative B	Alternative C
Sale price per unit A:(400-30);B:(400-40);C(400-20 i.e. 5%of 400)	$370	$360	$380
Less: Variable cost per unit A:(200-25)	$175	$200	$200
Contribution per unit (A)	$195	$160	$180
No.of units sales forecast for remaining period of year(B)	2200 units	2700 units	2000 units
Total Contribution for remaining period (A*B)	$429,000	$432,000	$360,000
Contribution earned in first five months (Note 1)	$70,000	$70,000	$70,000
Total contribution for year	$499,000	$502,000	$430,000
Less: Fixed cost C:(120000-10000)	$(120,000)	$(120,000)	$(110,000)
Profit before tax	$379,000	$382,000	$310,000
Less: Tax @40%	$(151,600)	$(152,800)	$(124,000)
After profit tax	$227,400	$229,200	$186,000

Therefore Campbell company can select any of Alternative A or B to acheive its annual after tax profit of $216,000 but it is better to go with altenative B as it is more profitable

Note 1: Contribution earned in first five months:

No.of units sold = 350 units

Contribution per unit = 400-200 = 200 per unit

there for total contribution for 350 units = 350*200 = $70,000