Question

The following monthly data in contribution format are available for the MN Co. and its only product:

	Total	Per Unit
Sales…………………………………………………………….	$83,700	$279
Variable expenses……………………………………….	32,700	109
Contribution margin……………………………………	51,000	$170
Fixed expenses…………………………………………….	40,000
Net operating income………………………………….	$11,000

             

The Company is currently selling 300 units of product per month.

Required: (each point is separate)

1. Management is contemplating the use of plastic gearing rather than metal gearing in its product. This change would reduce variable expenses by $18 per unit. The company's sales manager predicts that this would reduce the overall quality of the product and thus would result in a decline in sales to a level of 250 units per month. Should this change be made?
2. Management wants to increase sales and feels this can be done by cutting the unit selling price by $22 and increasing the advertising budget by $20,000 per month. Management believes that these actions will increase unit sales by 50%. Should these changes be made?
3. MN Co. is expecting to experience severe financial difficulties and has applied for a large guaranteed loan. As a condition for obtaining the guarantee, the Bank mandates that the company significantly reduce its break-even point. Highlight and discuss with examples all possible strategies the company might consider to meet required conditions.

Answer 1

	Units	300	250	450
		Per Unit	Total	Per Unit	Part (a)	Per Unit	Part (b)
	Sales	$       279	$       83,700	$          279	$              69,750	$       257	$            115,650
Less:	Variable Cost	$       109	$       32,700	$            91	$              22,750	$       109	$              49,050
	Contribution	$       170	$      51,000	$          188	$              47,000	$       148	$              66,600
Less:	Fixed Expenses		$       40,000		$              40,000		$              60,000
	Net Operating Income		$      11,000		$                7,000		$                6,600
	Decision		-		No since Net operating income is reduced to 7000		No since Net operating income is reduced to 6600

Part (c)

The break-even point is calculated by using the formula: Total Fixed Costs divided by Contribution Margin per Unit. So MN Co. can reduce their break-even point by

1) reducing the amount of fixed costs : This can happen if they outsource as it will lower their fixed costs;

2) reducing the variable costs per unit which will increase the unit's contribution margin : Like in Part (b) MN Co. reduced its variable cost by using the plastic gearing. It resulted in increasing the contribution margin per unit to $188 up from $170.

3) Increase selling prices : However it is not possible in a competitive market and might result in decrease in the number of units sold. But a company can lure its customer by providing additional offers with their product like gift wrapping, a personalized card, or an additional warranty.