Question

1. GreatMall 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. (12 points)

2. The following CVP information is for two different companies, Saturn Ltd. and Venus Ltd. Study the information carefully.

	Saturn Ltd	Venus 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 Venus’s profit increase at a faster rate than Saturn’s when the sales increased from 3000 units to 6000 units? Explain your answer clearly. (12 points)

Answer 1

A. Impact of each proposal on the break-even point:

Proposal 1: Launch an advertising campaign- Advertisement campaign will incur hefty sum of money on advertisement expenses. The result would be increased sales in terms of quantity sold if advertisement is successful in convincing the target customer group. Advertisement expenses can be categorised as fixed costs or variable costs depending on amount of expenditure incured and it's allocation in each periodic budget. However, If we assume advertisement expenses to be fixed costs then it will increase company's breakeven point in terms of units to be sold as contribution margin (i.e., Sales price - variable costs) will remain same. This means that company will have to sell more units to achieve the same amount of profit as before because of increased fixed costs. Impact on break-even point would be that company have to sell more units of the product to achieve the break-even point as compared to previous break-even point. So, break-even point will increase.

Proposal 2: Reduce selling price of products- Reduction in selling price of products will result in decrease in contribution margin (i.e., Sales price - variable costs). This means that company will have reduced profits from each unit sold to customers. Reduction in selling price boost the sale of company's product. It is also a sales strategy to increase the quantity of sales i.e., increase the number of units sold. Reduced selling price of products results in reduced contribution margin leading to increase in break-even point in terms of number of unit sold to achieve the same amount of profit as before. So, impact on break-even point would be that company have to sell more units of the product to achieve the break-even point as compared to previous break-even point. Hence, break-even point will increase.

Proposal 3: Reduce variable costs by installing more efficient equipment, but will increase fixed costs- Reduction of variable costs by installing more efficient equipment will increase contribution margin (i.e., Sales price - variable costs). This means that each unit sold will give increased profits to company if we exclude fixed costs of product. But installation of new equipment will also increase fixed costs of depreciation. This means that company's fixed costs will also increase at the same time due to installation of new equipment. Now there can be two possible effects of this proposal on break-even point. Firstly it can be possible that breakeven point reduce because increase in contribution margin is more than increase of fixed costs, so this will reduce break-even point as compared to previous break-even point. Secondly, it can be possible that breakeven point increase because increase in contribution margin is less than increase of fixed costs, so this will increase break-even point as compared to previous break-even point. So, impact on break-even point can be more appropriately commented if we know the actual figures. But in the absence of actual figures, there can be two possible impact on break-even point as discussed above.

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