Question

Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 89,000 units for $70 per unit. The variable production costs are $40, and fixed costs amount to $1,490,000. Production engineers have advised management that they expect unit labor costs to rise by 20 percent and unit materials costs to rise by 15 percent in the coming year. Of the $40 variable costs, 45 percent are from labor and 20 percent are from materials. Variable overhead costs are expected to increase by 25 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 4 percent as a result of increased taxes and other miscellaneous fixed charges.

The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 7 percent during the year.

Required:

a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented.

b. Compute the volume of sales and the dollar sales level necessary to provide the 7 percent increase in profits, assuming that the maximum price increase is implemented.

c. If the volume of sales were to remain at 89,000 units, what price change would be required to attain the 7 percent increase in profits? Calculate the new price.

Answer 1

(a)	Volume in units	=	95108
	Sales	=	7323317
(b)	Volume in units	=	97164
	Sales	=	7481610
(c)	New Price	=	79.63
	Workings:
(a)	Current Profit	=	[Units sold X (Selling price - Variable cost)] - Fixed cost
		=	[89,000 units ($70-$40)] - $1490,000
		=	1180000
	New Variable cost	=	Labor cost + Material cost + Overheads
		=	(120% X 45% X $40) + (155% X 20% X $40) + (125% X 35% X $40)
		=	48.3
	New Selling Price	=	$70 X 110%
		=	77
	New Fixed cost	=	$1490,000 X 104%
		=	1549600
	Current Profit	=	[Units sold X (Selling price - Variable cost)] - Fixed cost
	1180000	=	[Units sold ($77-$48.3)] - $1549600
	1180000	=	(Units sold * 28.7) - 1549600
	Units sold	=	(1180000 + 1549600) /28.7
	Units sold	=	95108
	Sales	=	Units sold X Selling price
		=	95108 X $77
		=	7323317
(b)	Profit to be achieved	=	$1180000 X 107%
		=	1239000
	Target profit Units sold	=	(Fixed cost + Target profit ) / (Selling price - Variable cost)
	Units sold	=	(1549600+1239000)/(77-48.3)
	Units sold	=	97164
	Sales	=	Units sold X Selling price
		=	97164 X $77
		=	7481610
(c)	Profit to be achieved	=	$1180000 X 107%
		=	1239000
	Profit to be achieved	=	[Units sold X (Selling price - Variable cost)] - Fixed cost
	1239000	=	[89000 units (Selling price - $48.3)] - $1549600
	1239000+1549600	=	89000 units (Selling price - $48.3)
	2788600	=	89000*Selling price - 890000 * 48.3
	2788600	=	89000 *Selling price -4298700
	89000*selling price	=	2788600+4298700
	89000*selling price	=	7087300
	Selling price	=	7087300/89000
	Selling price	=	79.63