Question

HabibMall reported a loss of $30,000 in 2019 and its managers are now considering what to do about this loss. They hope to make a profit in the next 6 months, and the following proposals have been made:

• Launch an advertising campaign.
• Reduce selling price of products
• Reduce variable costs by installing more efficient equipment, but will increase fixed costs.

TASK

Assuming the business intends to adopt each proposal individually, evaluate the impact that each proposal will have on the break-even point. (14 points)

2. The following CVP information is for two different companies, Hob's Ltd. and Mill's Ltd. Study the information carefully.

	Hob's Ltd	Mill's Ltd
Selling price	$20	$25
Variable cost	$12	$10
Fixed cost	$8,000	$36,000
Break-even point	1000 units	2,400 units
Profit at 3000 unit sales	$16,000	$9,000
Profit at 6000 unit sales	$40,000	$54,000

TASK

Why did Mill's profit increase at a faster rate than Hob's when the sales increased from 3000 units to 6000 units? Explain your answer clearly. (18 points)

Answer 1

A)

Launch an advertising campaign :

It is a fixed expense for the firm. Because expenses incurred for advertising campaign doesn't proportionally variable with number of units sold. It doesn't not impact contribution per unit but it increases total fixed cost. Thus it needs to have more units of sales to maintain break even level.

Reduce selling price of the products :

If everything remain constant, then reduction of selling price, decreases contribution per unit. It resulted more units of sales to maintain break even level .

Reducing variable costs by installing more efficient equipment :

It will reduce contribution per unit but at the same time it will increase total fixed cost . Here, to get the benefits company should sale more outputs . If change in contribution per unit is greater than change in per unit allocated fixed cost ,then the company can get the advantage and BEP level would be comparatively lower.

B) Hob's limited :

Contribution per unit = Sales price per unit - COGS per unit = $ 20 - $12 = $ 8

Allocation of fixed cost on per unit output sold :

When 3,000 units sold = $ 8,000/ 3,000 = $ 2.67

When 6,000 units sold = $ 8,000 / 6,000 = $ 1.33

Per unit allocated fixed cost reduces by [$ 2.67 - $ 1.33] = $ 1.34

Mill's Limited :

Contribution per unit = sales price per unit - variable cost per unit = $ 25 - $10 = $ 15

Allocation of fixed cost on per unit output sold :

When 3,000 units sold = $ 36,000 / 3,000 = $ 12

When 6,000 units sold = $ 36,000 / 6,000 = $ 6

Per unit allocated fixed cost reduces by [ $ 12 - $ 6] = $ 6

Here, Mill's corporation are getting more benefits by reducing it's per unit fixed cost allocation than its competitors . If more outputs sold then operating profits of Mill's corporation would increase more because with increments in sales , per unit allocated fixed costs of Miller corporation reduces more than its competitors.