Question

Buffalo Company manufactures and sells adjustable canopies that attach to motor homes and trailers. For its budget, Buffalo estimated the following:

Selling price                               $420

Variable cost per canopy $205

Annual fixed costs                       $180,000

Net Income                                $250,000

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 $60 per unit. The sales forecast that at this significantly reduced price is which 2,850 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 using 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 $15,000 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.

Required:

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

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

Answer 1

(1)

Selling Price	420.00
Less: Variable Costs	205.00
Contribution Margin	215.00
Fixed Costs	180,000
Total Required Contribution	180,000	A
Contribution Margin Per Unit	215	B
Break Even Units	837.2	A/B
Desired Net Income	250,000
Desired EBT (250,000 / 70%)	357,143
Add: Fixed Costs	180,000
Total Required Contribution	537,143	A
Contribution Margin Per Unit	215.00	B
Target Units for Net Income	2,498	A/B

(2)

Alternative (A)

Sales (2,850 x $360)		1,026,000
Less: Variable Costs (2,850 x $205)	584,250
Annual fixed costs	180,000
Total Cost		764,250
EBT		261,750
Income Tax (30%)		78,525
Net Income		183,225

Alternative (B)

Sales (2,200 x $390)		858,000
Less: Variable Costs (2,200 x $195)	429,000
Annual fixed costs	180,000
Total Cost		609,000
EBT		249,000
Income Tax (30%)		74,700
Net Income		174,300

Alternative (C)

Sales (2,000 x $399)		798,000
Less: Variable Costs (2,000 x $205)	410,000
Annual fixed costs	165,000
Total Cost		575,000
EBT		223,000
Income Tax (30%)		66,900
Net Income		156,100

Alternative (A) is the best among all with a Net Income of $183,225. It still doesn't acheives the desired net income of $250,000 because of the sifnificant reduction in the Selling Price.