Question

M. Anthony, LLP, produces music in a studio in London. The cost of producing one typical song follows. Average Cost per Song: Labor, including musicians and technicians $ 17,200 Variable overhead, including clerical support 3,200 Fixed overhead 21,200 Marketing and administrative costs (all fixed) 28,080 Total cost per song $ 69,680 The fixed costs allocated to each song are based on the assumption that the studio produces 60 songs per month. Required: Treat each question independently. Unless stated otherwise, M. Anthony charges $82,000 per song produced. a. How many songs must the firm produce per month to break even? b. Market research estimates that a price increase to $92,000 per song would decrease monthly volume to 52 songs. The accounting department estimates that fixed costs would remain unchanged in total, and variable costs per song would remain unchanged if the volume were to drop to 52 songs per month. How would a price increase affect profits? c. Assume that M. Anthony's studio is operating at its normal volume of 60 songs per month. It has received a special request from a university to produce 30 songs that will make up a two-CD set. M. Anthony must produce the music next month or the university will take its business elsewhere. M. Anthony would have to give up normal production of 10 songs because it has the capacity to produce only 80 songs per month. Because of the need to produce songs on a timely basis, M. Anthony could not make up the production of those songs in another month. Because the university would provide its own musicians, the total variable cost (labor plus overhead) would be cut to $15,200 per song on the special order for the university. The university wants a discounted price; it is prepared to pay only $42,000 per song and believes a fee reduction is in order. Total fixed costs will be the same whether or not M. Anthony accepts the special order. Should M. Anthony accept the special order? d. Refer to the situation presented in requirement (c). Instead of offering to pay $42,000 per song, suppose the university comes to M. Anthony with the following proposition. The university official says, "We want you to produce these 30 songs for us. We do not want you to be worse off financially because you have produced these songs. On the other hand, we want the lowest price we can get." What is the lowest price that M. Anthony could charge and be no worse off for taking this order?

Answer 1

Fixed costs remains constant. So fixed costs are not considered while decision making. Only those fixed costs that change with decision are considered.

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CALCULATION OF CONTRIBUTION PER UNIT Particulars Amount Amount Sales Price $82,000 Less: Variable Costs Labor Cost $17,200 Variable Overhead $3,200 TOTAL VARIABLE COSTS $20,400 CONTRIBUTION PER UNIT $61,600 (Given) (Given) -$17,200 + $3,200 69680 Amount 60 Songs CALCULATION OF TOTAL FIXED COST Particulars Amount Total Songs Produced Fixed Overhead per SONG $21,200 Fixed Marketing & Admin $28,080 TOTAL FIXED COST PER SONG TOTAL FIXED COSTS (Given) (Given) -$21,200+ $28,080 =60 Songs x $49,280 per song $49,280 $2,956,800 We know that Break Even Point (BEP) =- Total Fixed Costs Contribution per Unit $2,956,800 Break Even Point (BEP) =- $61,600 = 48 Songs So, in order to Break Even Firm must produce 48 songs per month.

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CALCULATION OF CONTRIBUTION PER UNIT OF 30 Songs Order Particulars Amount Amount Selling Price per Song $42,000 LESS: Total Variable Cost -$15,200 (Given) CONTRIBUTION PER UNIT $26,800 =$42,000-$15,200 Total Songs to be produced 30 Songs TOTAL CONTRIBUTION DUE TO 30SONGS $804,000 =$26,800 x 30Songs Calculation of Loss of Contribution due to Loss of 10 Songs = Actual Contribution per unit x 10 Songs 188000 = $ 61,600 x 10 Songs = $ 616,000 Increase in Contriibution if Order of 30Songs Accepetd =$804,000 - $616,000 =$188,000 Since Acceptance of new songs results in additional contribution of $188,000, new songs should be accepted. Though the contribution per unit of 30 songs ($26,800) is less than the actal contribution ($61,200), the new order of 30 songs utilises the idle capacity of 20 songs (80-60). Hence, it results in additional Contribution and Profit.

CALCULATION OF MINIMUM PRICE PER SONG Particulars Amount Amount Total Songs 30 Songs Variable Cost per Song $15,200 TOTAL VARIABLE COSTS $456,000 LOSS OF CONTRIBUTION $616,000 TOTAL COST OF PRODUCING 30 SONGS $1,072,000 MINIMUM PRICE PER SONG $35,733.33 -30 Songs x $15,200 (Calculated in (c)) =$456,000 + $616,000 =$1,072,000/ 30Songs