Question

Nancy Lee iis student who has a business idea which she envisages will pay off her student loan and might possibly lead to a long-term business career. Her idea is to hire a machine to make decorative i-phone covers and sell them on-line and hopefully generate lots of cash. She thought that she would start with 3 styles, Lego, Tiger and Whale and sell them for $25, $25 and $20 per cover respectively. After a bit of market research she predicted that she could sell 600 Lego covers, 1080 Tiger covers and 720 Whale covers in the next year. The hire of the manufacturing machine would be $29,181 per annum and other fixed costs such as bank interest (luckily her Mum and Dad will act as guarantors!), website and warehouse rental would come to $1,400 per month. Her only other costs would be materials at $7/Lego cover, $6/Tiger cover and $5/Whale cover. She would not charge for her own labour until she gets established.  

Required: (a) What is the breakeven point for Nancy’s business this year, in terms of: (i) total number of covers to be sold; and (ii) number of each type of cover to be sold?

(b) On the basis of Nancy’s predictions, what would be the business’s estimated profit (before tax) for the year?

(c) If the total actual sales for all covers turned out to be 2,300 at the end of the first year, what would be the Sales Quantity variance for the Tiger and Whale covers, based on contribution margin?

(d) Should Nancy go ahead with her proposed business venture? Explain why or why not, or any modifications you think she should make.  

Answer 1

a. (i) Total fixed cost = Hire Cost + other fixed costs

= $29,181 + $16,800 (1400*12)

= $45,981

Breakeven point is one where there is no profit, no loss.

Contribution = $45,981

Contri per unit for each product:-

Particulars	Lego	Tiger	Whale
Selling price (a)	25	25	20
Variable cost	(7)	(6)	(5)
Contribution per unit (b)	18	19	15
Contribution % (b/a)*100	72%	76%	75%

Overall Contribution = Total contribution/Total Selling price * 100

= (18*600) + (19*1080) + (15*720) / (25*600) + (25*1080) + (20*720)

= 42,120/56,400 * 100

= 74.68%

Contribution per unit = $42,120/2400 (600 + 1080 + 720)

= $17.55

Break even point = Fixed Costs/Contribution margin per unit

= $45,981/17.55

= 2,620 units

(b) Profit/(Loss) = Contribution - Fixed Cost

= (600*18) + (1080*19) + (720*15) - $45,981

= 42,120 - 45,981

= (3,861)

(c) Expected Quantity of sale = 2400 units

Lego - 600

Tiger - 1080

Whale - 720

Contribution margin:-

Lego = 72%

Tiger = 76%

Whale = 75%

Sale ratio = 600:1080:720

If sell quantity is 2300,

Lego = 2300 * 600/2400

= 575 units

Tiger = 2300 * 1080/2400

= 1035 units

Whale = 2300 * 720/2400

= 690 units

Variance:-

Tiger = (1080 - 1035)/1080 * 100

= 4.17%

Whale = (720 - 690)/720 * 100

= 4.17%

(d) Nancy should not go ahead with the business venture because she will be at a loss is she goes on for the venture.

She should try to increase the selling price of the covers by $1-$2 and she will at a profit or break even stage.