Question

1. The following information relates to a fertiliser business for 2015:

Volume of product sold 100,000 tonnes Selling price €125 per tonne Average net profit €10 per tonne Contribution margin €30 per tonne Current plant capacity (2015) 125,000 tonnes

In 2016 the company plans to increase its profit and sales substantially, but in order to do so it will have to reduce its selling price by 4%. The variable cost per unit will not change.   

However, if the company wishes to increase production above its current plant capacity levels, it will require additional machinery which will increase the overall fixed costs by €250,000 and will bring the plant capacity to an estimated 160,000 tonnes.

Assuming the company decides to proceed with its plan to reduce its selling prices in 2016, but not install the new machinery, calculate the following:

i. The sales volume and value required to give the same profit in 2016 as was achieved in 2015; and

ii. The increase in profit that the company could achieve in 2016 by increasing sales to its existing full capacity of 125,000 tonnes.

Assuming the company decides to proceed with the installation of the new machinery,calculate the following:

iii. The break-even sales volume in 2016; and

iv. The sales volume and value required to achieve a profit in 2016 that is 25% higher than the profit achieved in 2015.

Answer 1

In 2015:

Selling price per tonne = €125

Contribution margin =€30

Hence, Variable cost = 125-30 =€95

Total profit = 100000*10 = €1000000

Hence, fixed costs = 30*100000 -1000000 = €2000000

1. Profit required in 2016 = €1000000

Revised sale price per unit = 125*.96 = €120

Variable cost = €95

Revised contribution per unit = €25

Hence, Sales volume Fixed costs+ Profits required/Contribution per unit

= 2000000+1000000/25 = 120000 units

Hence Sales value = 120000*120 = €14400000

2.Profit at full capacity = 125000*25-2000000 = 3125000-2000000 = €1250000

Increase in profit = 1250000-1000000 = €250000

3. Revised fixed costs = 2000000+250000 = €2250000

Break even sales = Total fixed costs/Contribution per unit

2250000/25 = 90000 tonnes

4. Profit target =1000000*1.25 = €1250000

Total fixed costs = €2250000

Hence, contribution required = €3500000

Sales volume required = 3500000/25 = 140000 tonnes

Sales value = 140000*120 = €16800000

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