Question

QUESTION 4 (20)

The following budgeted details for 2020 relate to a product manufactured by Kito Limited:

Sales R50 000 Variable cost per unit sold R7.50 Total fixed cost R12 500 Sales volume 2 500 units Consider the following situations independently:

4.1 Calculate the operating profit. (3)

4.2 Suppose sales increase by R10 000 without changes to any costs. By what amount will contribution margin and operating profit increase? (2)

4.3 Suppose fixed costs increase by R3 000. By how much must sales increase if operating profit was to remain unchanged? (2)

4.4 Would you recommend an advertising programme costing R5 000 that would generate an additional R10 000 of sales? Why? (2)

4.5 Calculate the volume of sales required to achieve an operating profit of R20 000. (3)   

Consider the following situations independently and in each case motivate your answer by doing the relevant calculations:

4.6 Should management consider a drop of R2 per unit in the selling price if sales volume is expected to increase by 200 units? (4)

4.7 Should management adopt the following proposal? Decrease the selling price by R4 and increase marketing costs by R8 000 with the expectation of an increase in sales to 5 000 units. (4)

Answer 1

Here sales = R 50000 and units sold are 2500 units , thus sales price per unit = 50000/2500 = R 20.  

Variable cost per unit = R 7.5 ,thus variable cost = 2500 * 7.5 = R 18750 , fixed cost given = R 12500

Here contribution per unit = Selling price per unit - variable cost per unit = 20 - 7.5 = 12.5

Contribution margin ratio = Contribution margin per unit / sales price per unit = 12.5 / 20 = 62.50%.

Based on the above information the solution will be as follows:

4.1 Operating Profit :  

Particluars	Amount
Sales	R 50000
Less: Variable Cost	18750
Contribution margin	31250
Less: Fixed cost	12500
Operating Profit	R 18750

Operating Profit = R 18750.

4.2   sales increase by R10 000 without changes to any costs. here it is assumed that even variable costs are not increased, as sales in increased due to selling price.. However an alternate solutio is also given for better understanding.

Particluars	Amount
Sales	R 60000
Less: Variable Cost	18750
Contribution margin	41250
Less: Fixed cost	12500
Operating Profit	R 28750

The contributiion margin will become = 41250 i.e an increase by 10000 and Operating profit will become R 28750  increase by R 10000.

However if the variable cost also increases in proportion to the sales , then the contribution margin would be = R 37500 i.e an increase of R 6250. and operating profit will also incraese by R 6250.

.

4.3 fixed costs increase by R3 000. By how much must sales increase if operating profit was to remain unchanged?

operating profit in original case = R 18750 , and Fixed cost increse by R 3000 so fixed cost = 12500 + 3000 = R15500

Desired Sales = ( Desired profit + Fixed cost ) / contribution margin ratio

Desired sales = ( 18750 + 15500 ) / 62.50% = 34250 / 62.50% = R 54800 .

So increase of sales = Desired sales  - Existing sales = 54800 - 50000 = 4800.

sales must increase by R 4800.

4.4 Would you recommend an advertising programme costing R5 000 that would generate an additional R10 000 of sales? Why?

The sales increase by 10000 and fixed cost be 5000 the effect will be as follows:

Particluars	Amount
Sales	R 60000
Less: Variable Cost	22500
Contribution margin	37500
Less: Fixed cost	17500
Operating Profit	R 20000

The Operating profit is Increasing by R 1250, so it is recommended for an advertisig programming, because it will generate an additinal operating profit.

4.5 Calculate the volume of sales required to achieve an operating profit of R20 000

Desired sales =( Target profit + Fixed cost ) / contribution margin ratio

Desired sales = ( R20000 + R12500) / 62.50% = R 32500/62.50%

Thus volume of sales required to achieve an operating profit of R20 000 = R 52000

4.6 Should management consider a drop of R2 per unit in the selling price if sales volume is expected to increase by 200 units

if management drops R 2 per unit the selling price = R 18 , and impact is as follows:

Particluars	Amount
Sales	48600
Less: Variable Cost	20250
Contribution margin	28350
Less: Fixed cost	12500
Operating Profit	15850

If the selling price is dropped there is a reduction in operaating profit by R 2900, so it is not recommended.

Should management consider a drop of R2 per unit in the selling price if sales volume is expected to increase by 200 units - No.

4.7 Should management adopt the following proposal? Decrease the selling price by R4 and increase marketing costs by R8 000 with the expectation of an increase in sales to 5 000 units.

The impact will be as follows:

Particluars	Amount
Sales	R 80000
Less: Variable Cost	37500
Contribution margin	42500
Less: Fixed cost	20500
Operating Profit	R 22000

Yes the management should adopt the proposal as the operating profiit is increased by R 3250 than existing,