Question

A newly organized manufacturing business plans to manufacture and sell 50,000 units per year of a new product. Direct materials cost Rs. 47 per unit while direct labor cost is Rs. 32. Manufacturing overheads has two parts: variable part is Rs. 4 per unit while fixed costs are Rs. 340,000 per year. Selling expenses are Re.1 per unit while administrative expenses are Rs. 200,000 for a year.

1. What should the company establish as the selling price per unit if it sets a target of earning an operating income of Rs. 260,000 by producing and selling 50,000 units during the first year of operations?
2. At the unit price computed in part a, how many units must the company produce and sell to break even? Calculate breakeven point in currency value too.
3. What will be the margin of safety (in units and currency) if the company produces and sells 50,000 units at the sales price computed in part a)?
4. Compute operating income at 50,000 units.
5. Due to heavy competition, the marketing manager thinks that the selling price must not be more than Rs. 94, in order to maintain sales of 50,000 units. Can the company survive by making profits at this price? Show calculations to justify your answer.

Answer 1

Question A

Let Sales Price per Unit = X

Then Sales Revenue = Units Sold * Sales Price per Unit

Sales Revenue = 50,000 * X

Sales Revenue = $ 50,000 X

Variable Costs per Unit = Direct Materials Cost per Unit + Direct Labour Cost per Unit + Variable Manufacturing Overhead per Unit + Variable Selling and Administrative Expenses per Unit

Variable Costs per Unit = 47 + 32 + 4 + 1

Variable Costs per Unit = $ 84

Variable Costs = Units Sold * Variable Costs per Unit

Variable Costs = 50,000 * 84

Variable Costs = $ 42,00,000

Target Operating Income = Sales - Variable Costs - Fixed Manufacturing Overhead Costs - Fixed Selling and Administrative Costs

Sales = 50,000 X

Target Operating Income = Rs 260,000

Variable Costs = Rs 42,00,000

Fixed Manufacturing Overhead = Rs 340,000

Fixed Selling and Administrative Costs = Rs 200,000

260,000 = 50,000 X - 42,00,000 - 340,000 - 200,000

50,000 X = 260,000 + 42,00,000 + 340,000 + 200,000

50,000 X = 50,00,000

X = 50,00,000 / 50,000

X = Rs 100 Per Unit

Then Sales Price of Rs 100 per Unit should be established to earn Target Profit of Rs 260,000 on selling of 50,000 Units.

Question B

Break Even Point in Units = Total Fixed Costs / Contribution Margin per Unit

Contribution Margin per Unit = Sales Price per Unit - Variable Costs per Unit

Sales Price per Unit = Rs 100

Variable Costs per Unit = Rs 84

Contribution Margin per Unit = 100 - 84

Contribution Margin per Unit = Rs 16

Total Fixed Costs = Rs 540,000 (Fixed Manufacturing Overhead + Fixed Selling and Administrative Expenses)

Break Even Point in Units = 540,000 / 16

Break Even Point in Units = 33,750 Units

Break Even Point in Dollars = Total Fixed Costs / Contribution Margin Ratio

Contribution Margin Ratio = Contribution Margin per Unit / Sales Price per Unit * 100

Contribution Margin per Unit = 16 / 100 * 100 = 16%

Break Even Point in Dollars = 540,000 / 16%

Break Even Point in Dollars = Rs 33,75,000

Question C

Margin of Safety Sales in Units = Total Sales in Units - Break Even Sales in Units

Total Sales in Units = 50,000 Units

Break Even Point in Units = 33,750 Units

Margin of Safety Sales in Units = 50,000 - 33,750

Margin of Safety Sales in Units = 16,250 Units

Margin of Safety Sales in Dollars = Total Sales in Dollars - Break Even Sales in Dollars

Break Even Sales in Dollars = $ 33,75,000

Total Sales in Dollars = Rs 50,00,000 (Total Sales in Units * Sales Price per Unit)

Margin of Safety Sales in Dollars = 50,00,000 - 33,75,000

Margin of Safety Sales in Dollars = Rs 16,25,000

Question D

Particulars	Amount
Sales Revenue	50,00,000
Less: Variable Costs	(42,00,000)
Contribution Margin	8,00,000
Less: Fixed Costs	(5,40,000)
Operating Profit / (Loss)	2,60,000

Sales Revenue = 50,000 Units * Rs 100 per Unit

Sales Revenue = Rs 50,00,000

Question E

Particulars	Amount
Sales Revenue	47,00,000
Less: Variable Costs	(42,00,000)
Contribution Margin	5,00,000
Less: Fixed Costs	(5,40,000)
Operating Income / (Loss)	(40,000)

No the Company can not survive by setting a price of Rs 94 per Unit becuse with that price the company is nit able to meet its fixed costs due to which it will result in a loss of Rs 40,000.

Notes;-

Sales Revenue = 50,000 Units * Rs 94 per Unit

= Rs 47,00,000

Variable Costs = 50,000 Units * Rs 84 per Unit

= Rs 42,00,000

Fixed Costs = Rs 540,000