Question

In: Accounting

Mary Poppins, a friend of yours, has recently set up a small business making curtains. She...

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.

Solutions

Expert Solution

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
Profit

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