Question

Simnet Solutions Inc. manufactures and sells cell phones. For the 2020 business plan, the company estimated the following:

Selling Price per Unit   $750
Variable Cost per Unit   $450
Annual Fixed Cost   $180,000
Net Income After Tax   $360,000
Tax Rate   25%
The January financial statements reported that sales were not meeting expectations. For the first 3 months of the year, only 400 units had been sold at the established price. With variable cost staying as planned, it was clear that 2020 after tax projection would not be reached unless some action was taken. A management committee presented the following mutually exclusive alternatives to the president.
Reduce the selling price by $60. The sales team forecast that with a significantly reduced selling price 3,000 units can be sold in the remainder of the year. Total fixed and variable unit cost will stay as budgeted.
Lower variable cost per unit by $20 through the use of less expensive direct materials. The selling price will also be reduced by $40, and sales of 2,800 units are expected for the remainder of the year.
Cut fixed costs by $20,000 and lower the selling price by 5%. Variable cost per unit will be unchanged and sales of 2,500 units are expected for the remainder of the year.
PROBLEM 3 INSTRUCTIONS
Under the current production, policy determines the number of units that the company must sell to:
break-even
achieve its desired operating income
Determine which alternative the company should select to achieve its desired operating income.

Answer 1

1. Calculation of breakeven units

Selling price per unit = 750

Variable Cost per unit = 450

Contribution per unit = SP pu - VC pu

=750 - 450

= 300

Breakeven units = Fixed cost / Contribution pu

= 180000 / 300

= 600 units

2.

Tax Rate = 25%

Desired Operating Income = PAT / (1 - Tax Rate)

= 360000 / 0.75

= 480000

Required Contribution = fixed cost + desired operating profit

= 180000 + 480000

= 660000

Required units for desired operating profit

= Reqd contribution / contr p.u.

= 660000 / 300

= 2200 units

3. Analysis of various proposed alternatives

Proposal - I

Total Sales = (750 - 60) * 3000

= $2,070,000

Total Variable cost = 3000 * 450

= $ 1,350,000

Operating profit = sales - VC - FC

= 2070000 - 1350000 - 180000

= $540,000

Proposal- II

Total Sales = (750 - 40) * 2800

= $1,988,000

Total Variable Cost = 2800 * (450 - 20)

= $1,204,000

Operating Profit = 1988000 - 1204000 - 180000

= $604,000

Proposal - III

Fixed Cost = 180000 - 20000

= $160,000

Operating Profit

= Sales - Variable Cost - FC

= (2500 * 750 * 0.95) - (2500 * 450) - 160000

= 1781250 - 1125000 - 160000

= $496,250

Decision: As the operating profit is the highest under Proposal - II, therefore we will select Proposal - II.

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