Question

Mary Poppins, a friend of yours, has recently set up a small business making curtains. She has supplied you with the following figures, and has asked your advice on a number of issues:

Costs per month	R
Materials	4 100
Labour	5 000
Production overheads	2 000
Selling and distribution overheads	1 000
Administration overheads	500

The above costs are based on producing and selling 1 200 pairs of curtains per month at a selling price of R15 each.

80% of labour costs are fixed, as are 75% of production overheads, 60% of selling and distribution overheads, and 100% of administration overheads. All other costs vary directly with output.

Mary wants to know:

1. How much profit she will make at the proposed production level and selling price?(3)

b)      How many pairs of curtains she needs to sell to break even at this price?     (3)

c)      If sales are slower than expected, by how much can she reduce her selling price in order to maintain the budgeted level of sales without making a loss?               (4)

d)     Mary estimates her maximum capacity as 1 500 curtains: would it be worthwhile to drop the price in order to increase sales to capacity? If so, by how much?      (5)

e)    If Mary bought another machine, she could increase her production capacity to 2 500 curtains. Repayments on the machine would be R700 per month, and she would need an extra member of staff, costing R1 000 per month. She would also have to pay a bonus to all staff of 50 cents per pair of curtains, over and above their current wages, and variable production overheads would increase by 30 cents per pair of curtains.

         In order to increase sales, she would have to reduce the price: she estimates demand at different price levels to be as follows:

Price	Estimated monthly demand
R14	1 500
R13	2 000
3R12	2 500

        

            What would be the optimum price?                                                                      (10)

Required:

Advise Mary on each of the above points, showing your calculations, explaining both the financial and non-financial implications of each where appropriate.

Answer 1

Particulars	Amount ( in R)	Fixed	Variable
Materials	4100	0	4100
Labour	5000	4000	1000
Production Overheads	2000	1500	500
Selling and Distribution Overheads	1000	600	400
Administration Overheads	500	500	0
		6600	6000
Current Selling Units	1200 Pairs
Current Selling Price per Pair	R 15 Each Pair
a)
Current Selling Unit X Current Selling Price
Selling Value 1200 X 15R =	18000
Variable Cost
Material	4100
Labour	1000
Production Overheads	500
	12400
Indirect Cost
Labour ( Fixed)	4000
Production Overheads ( Fixed)	1500
Selling Overhead	1000
Admin Overhead	500
Profit	5400

b) Breakeven Point, where Profit = Zero, able to cover it cost only
Selling Price		15 R
Variable Cost	6000/1200	5 R
Contribution Per Unit	10 R
Fixed Cost	6600
So, Break Even Equation
Contribution = Fixed Cost + Profit
Where Profit is Zero
10 R X Sale Units = 6600 + 0
660 Units ( Pair of Curtains)

c) It means , Price is reducing only to maintian the budgeted level of sale
Let Suppose price of Pair of Curtain be X
So , Sale Value = 1200 X
Variable Cost	6000
Contribution	1200 X - 6000
Fixed Cost	6600
Profit	Zero	As Assumed making profit NIL, it means not incurring loss
So,
1200 X - 6000= 6600+ 0
X = 6000+6600 / 1200
X = 10.5 R
Hence Reduction in price is upto 15 R - 10.5 R = 4.5 R

d) So, In Order to increase the capacity to 1500
So inorder to Increase the production Variable Cost is
6000 X 1500 / 1200 = 7500 R
Fixed Cost remain Same as 6600 R
In order to increase the Sale , Budgeted Profit needs to be remain constant
So, Sale Value = 1500 X
Variable Cost	7500 R
Contribution	1500 X - 7500 R
Fixed Cost	6600R
Profit		5400 R
So,
5400 R = 1500 X - 7500 R - 6600 R
X = 13 R
Hence Rduction in price is upto 15 R - 13R = 2 R

e)  

	R14	R13	R12
Selling Units	1500	2000	2500
Sale Value	21000	26000	30000
Variable Cost	7500	10000	12500
Variable Overhead ( Bonus)	188	250	313
Total Variable Cost	7688	10250	12813
Conribution	13313	15750	17187
Fixed Cost	6600	6600	6600
Other FC	700	700	700
Staff Bonus	3125	4167	5209
Total FC	10425	11467	12509
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