Question

Break-Even in Units, After-Tax Target Income, CVP Assumptions Campbell Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Campbell developed its business plan for the year based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $120,000. Campbell’s after-tax profit objective was $219,000; the company’s effective tax rate is 40 percent. While Campbell’s sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the after-tax profit projection for the year would not be reached unless some actions were taken. Campbell’s president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president:

A. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,100 units for the remainder of the year are forecast.

B. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,800 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted.

C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 1,900 units are expected for the remainder of the year.

Required: 1. Determine the number of units that Campbell Company must sell in order to break even assuming no changes are made to the selling price and cost structure.  

2. Determine the number of units that Campbell Company must sell in order to achieve its after-tax profit objective.

Determine which one of the alternatives Campbell Company should select to achieve its annual after-tax profit objective. Be sure to support your selection with appropriate calculations.

Answer 1

Question 1

Break Even Point in Units = Fixed Costs / Contribution Margin per Unit

Fixed Costs = $ 120,000

Contribution Margin per Unit = Sales Price per Unit - Variable Costs per Unit

Sales Price per Unit = $ 400

Variable Costs per Unit = $ 200

Contribution Margin per Unit = 400 - 200

Contribution Margin per Unit = $ 200

Break Even Point in Units = 120,000 / 200

Break Even Point in Units = 600 Units

Question 2

Target Sale in Units to earn After Tax Profit of $ 219,000 = (Fixed Costs + Target Profit before Tax) / Contribution Margin per Unit

Fixed Costs = $ 120,000

Target Profit Before Taxes = $ 365,000

Contribution Margin per Unit = Sales Price per Unit - Variable Costs per Unit

Sales Price per Unit = $ 400

Variable Costs per Unit = $ 200

Contribution Margin per Unit = 400 - 200

Contribution Margin per Unit = $ 200

Target Units to be sold to earn After Tax Profit of $ 219,000 = (365,000 + 120,000) / 200

= 2,425 Units

Notes

Target Profit Before Taxes = Target Profit After Taxes / (1 - Tax Rate)

Target Profit Before Taxes = 219,000 (1- 0.40)

Target Profit Before Taxes = 219,000 / 0.60

Target Profit Before Taxes = $ 365,000

Question 3

Alternative B is the best Alternative being suggested as it helps in achieving the Target After Tax Profit of $ 219,000

Supporting Work:-

Alternative A

Reduce Sales Price = $ 370 per Unit

Reduce Variable Costs = $ 175 per Unit

Sales Revenue = 350 Units * $ 400 per Unit + 2,100 Units * $ 370 per Unit

= 140,000 + 777,000

= $ 917,000

Variable Costs = 350 Units * $ 200 per Unit + 2,100 Units * $ 175 per Unit

= 70,000 + 367,500

= $ 437,500

Fixed Costs = $ 120,000

Profit Before Taxes = Sales Revenue - Variable Costs - Fixed Costs

Profit Before Taxes = 917,000 - 437,500 - 120,000

Profit Before Taxes = $ 359,500

Profit After Taxes = Profit Before Taxes * (1-Tax Rate)

Profit After Taxes = 359,500 * (1-0.40)

Profit After Taxes = $ 215,700

Alternative B

Reduced Sales Price = $ 360 per Unit

Sales Revenue = 350 Units * $ 400 per Unit + 2,800 Units * $ 360 per Unit

= 140,000 + 1,008,000

= $ 1,148,000

Variable Costs = 350 Units * $ 200 per Unit + 2,800 Units * $ 200 per Unit

= 70,000 + 560,000

= $ 630,000

Fixed Costs = $ 120,000

Profit Before Taxes = Sales Revenue - Variable Costs - Fixed Costs

Profit Before Taxes = 1,148,000 - 630,000 - 120,000

Profit Before Taxes = $ 398,000

Profit After Taxes = Profit Before Taxes * (1-Tax Rate)

Profit After Taxes = 398,000 * (1-0.40)

Profit After Taxes = $ 238,800

Alternative C

Reduced Sales Price = $ 380 per Unit

Sales Revenue = 350 Units * $ 400 per Unit + 1,900 Units * $ 380 per Unit

= 140,000 + 722,000

= $ 862,000

Variable Costs = 350 Units * $ 200 per Unit + 1,900 Units * $ 200 per Unit

= 70,000 + 380,000

= $ 450,000

Fixed Costs = $ 110,000

Profit Before Taxes = Sales Revenue - Variable Costs - Fixed Costs

Profit Before Taxes = 862,000 - 450,000 - 110,000

Profit Before Taxes = $ 302,000

Profit After Taxes = Profit Before Taxes * (1-Tax Rate)

Profit After Taxes = 302,000 * (1-0.40)

Profit After Taxes = $ $ 181,200