Question

 

JK Manufacturing is considering a new product and is unsure about its price as well as the variable cost associated with it. JK's marketing department believes that the firm can sell the product for $500 per unit, but feel that if the initial market response is weak, the price may have to be 20% lower in order to be competitive with existing products. The firm's best estimates of its costs are fixed costs of $3.6 million and variable cost of $325 per unit. Concern exists with regard to the variable cost per unit due to currently volatile raw material and labor costs. Although the firm expects this cost to be about $325 per unit, it could be as much as 8% above that value. The firm expects to sell about 50,000 units per year.

a. Calculate the firm's breakeven point (BEP), assuming its initial estimates are accurate.

b. Perform a sensitivity analysis by calculating the breakeven point for all combinations of the sale price.

per unit and variable cost per unit. (Hint: There are four combinations.)

c. In the best case, how many units will the firm need to sell to break even?

d. In the worst case, how many units will the firm need to sell to break even?

e. If each of the possible price/variable cost combinations is equally probable, what is the firm's expected breakeven point?

f. Based on your finding in part (e), should the firm go forward with the proposed new product? Explain why.

Answer 1

with sales price 20 % lower

new sales price = 500 * 80 % = 400

with variable cost 8% above

new variable cost = 325 * 108 %= 351

a) Initial estimates are given in first row

so break even = 20,571 units

b) break even is calculated in the above table last row.

c)Best case scenario = 20,571 units at break even

d)Worst case scenario = 73,469 units at break even

e) Average of possile scenarios = (20,571 + 48,000 + 24,161 + 73,469) / 4

= 41,550 units

f) Yes ,the firm should proceed .They expect to sell 50,000 units which would be profitable in all scenarios but the worst case.Also the 50,000 is above the average break even 41,550 as calculated in (e).