Question

ABC Company manufactures and sells adjustable canopies that attach to motor homes and trailers. For its budget, ABC estimated the following: Selling price $420 Variable cost per canopy $205 Annual fixed costs $180,000 Net Income $240,000 Income Tax Rate 30% The May financial statements reported that sales were not meeting expectations. For the first 5 months of the year, only 350 units had been sold at the established price with variable costs as planned. It was clear that the net income projection for the year would not be reached unless some actions were taken. A management committee presented the following mutually exclusive alternatives to the president:

A. Reduce the selling price by $40 per unit. The sales forecast that at this significantly reduced price is which 2,800 units can be sold during the remainder of the year. Total fixed costs and variable costs per unit will stay as budgeted. B. Lower variable cost per unit by $10 through the use of less expensive direct materials and slightly modified manufacturing techniques. The selling price will also be reduced by $30 and sales of 2,200 units are expected for the remainder of the year. C. Reduce fixed costs by $10,000 and lower the selling price by 5%. Variable costs per unit will be unchanged and sales of 2,000 units are expected for the remainder of the year.

(1) If no changes are made to the selling price or cost structure, determine the number of units that ABC must sell to break even and achieve its net income objective.

(2) Determine which alternative ABC should select to achieve maximum net income.

Answer 1

Particulars	$
Sale price per unit	420
Variable cost per unit	205
Contribution per unit	215

Annual fixed cost = $ 180,000

(i) Break even qty = 180,000/215 = 837.21 or 838

ABC already sold 350 qty in first 5 months it needs to sell additional 838-350 = 488 qty

(ii) Target Net income = 240,000 , tax rate = 30%

Target net income before tax = 240000 / (1-30%) = $ 342,857

Fixed cost = 180,000

Required qty to achieve target = (342857+180000)/215 = 2,432

ABC in its first 5 months sold 350 qty, to achieve net income target of $ 240,000, it needs to sell additional 2,082 (2432-350) qty.

2.

Particulars	Option A	Option B	Option C
Sale price per unit	380	390	399
Variable cost per unit	205	195	205
Contribution per unit	175	195	194
Sales qty	2,800	2,200	2,000
Total contribution for remaining year	490,000	429,000	388,000
Contribution for first 5 months	75,250	75,250	75,250
Total contribution for the year	565,250	504,250	463,250
Fixed cost	180,000	180,000	170,000
Net income before tax	385,250	324,250	293,250
Tax @30%	115,575	97,275	87,975
Net income	269,675	226,975	205,275

Contribution for first 5 months = (420-205)*350= 75,250

Option 1 of reducing price $40 is more benefical and maximises net income.