Question

Smith & Smith Medical Clinic provides annual health check-up packages for all ages. The clinic charges $14,000 per package on average. The average variable costs per package are $10,500. The annual fixed cost is $980,000.

The following is the estimated income statement of Smith & Smith for 2018:

	$
Sales (300 packages)	4,200,000
Variable costs	3,150,000
Contribution margin	1,050,000
Fixed costs	980,000
Net profit	70,000

Required

1. Calculate the break-even point (in number of packages and in dollars of sales)

2. Smith & Smith wished to increase the net profit by 150%. What is the number of package needed to be sold to achieve this target?

3. The clinic is considering spending additional $1,000,000 in advertising programmes to promote the company’s health checkup products and it is expected that, with these programmes, sales volume can be doubled in 2018 with no change in selling price. Can Smith & Smith achieve the target of increased profit in (b) above if the clinic goes for the advertising cost?

Answer 1

(1).

Break-even point (in number of packages) = 280 packages

Break-even point (in dollars of sales) = $3920000

Explanation;

Break-even point (in number of packages);

Fixed costs / (Sale price – variable cost)

$980000 / ($14000 – $10500)

= $980000 / $3500

= 280 packages

Break-even point (in dollars of sales);

Fixed costs * Sale price / (Sale price – variable cost)

$980000 * $14000 / ($14000 – $10500)

= $980000 * $14000 / $3500

= $3920000

(2).

Number of package needed to be sold to achieve this target = 330 packages

Explanation;

Target profit $70000 + ($70000 * 1.5) = $175000

Number of package needed to be sold to achieve this target;

Fixed costs + Desired profit / (Sale price – variable cost)

$980000 + $175000 / ($14000 – $10500)

= $1155000 / $3500

= 330 packages

(3).

Sales (600 * $14000)	$8400000
Less: variable costs (600 * $10500)	($6300000)
Contribution margin	$2100000
Less: Fixed costs ($980000 + $1000000)	($1980000)
Net profit	$120000

Thus, it is clear that if the clinic goes for the advertising cost then Smith & Smith will not achieve the target of increased profit. Because target profit is $175000 whereas additional $1,000,000 in advertising programmes will result into net profit of $120000.