Question

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
R12	2 500

What would be the optimum price?

Answer 1

We will find the optimum price using the concept of Contribution Margin -

Contribution is calculated by deducting the variable expenses from the revenue generated. It provides us the amount that is available for fixed expenses and net profit. The higher the contribution margin, the better it is.

In the given question, following would be considered as variable costs -

Bonus to staff - Since the bonus is directly connected to the levels of production of curtains.

Variable Production Overheads - Since, it increases in proportion with the levels of production.

Note - Repayments on the machine and Cost of hiring an extra staff member would not be considered because these expenses are fixed, i.e., they do not vary with changes in the levels of production.

Calculation of Optimum Price -  

		Sale - 1500 Units	Sale - 2000 Units	Sale - 2500 Units
	Particulars	Per Unit	Amount	Per Unit	Amount	Per Unit	Amount
a	Sales	14	21,000	13	26,000	12	30,000
	Less : Variable Costs
b	Staff Bonus	0.25	375	0.25	500	0.25	625
c	Production Overheads	0.15	225	0.15	300	0.15	375
d	Total Variable Costs ( b + c )		600		800		1000
e	Contribution ( a - d )		20,400		25,200		29,000
f	Contribution Percentage ( ( e / a ) x 100 )		97.143%		96.923%		96.667%

The contribution % is highest at 1,500 units.

Therefore, the optimum price Mary should opt is R 14 at 1,500 units.