In: Economics
The following information is available for last month:
Sales (10,000 units x $120 per unit) $1,200,000
Variable expense (10,000 units x $80 per unit) $800,000
Contribution margin $400,000
Fixed Expenses $300,000
Operating Income $100,000
The company has no beginning or ending inventories. AKD’s product is in its growth stage and is positioned as an affordable quality product. Currently, competitor’s prices range from $110-$125 per unit.
a) Calculate the company's break-even point in units.
b) The marketing manager believes she can increase sales by 2,500 units by one of these 2 options:
Option 1: Increasing advertising, a fixed cost, by $15,000, or
Option 2: Decreasing sales price per unit to $115.
a.
Calculation of break-even point in units = Total Fixed cost in $ /
Contribution margin per unit
We know that:
Total fixed cost = $300000
Contribution margin per unit = S - V = $120 - $80 = $40
Let us put the values in the formula:
Break-even point in units = $300000 / $40 = 7500 units
(Answer)
Following is the test of what we found above:
(All fig. in $, except sale in units) | Original data | Breakeven point data |
Sale in units | 10000 | 7500 |
Sale price | 120 | 120 |
Sale value | 1200000 | 900000 |
Variable exp. @$80 per unit | 800000 | 600000 |
Contribution margin | 400000 | 300000 |
Fixed exp. | 300000 | 300000 |
Operating income | 100000 | 0 |
b.
Let us see the detailed working for existing option, option 1 and
option 2:
(All fig. in $, except sale in units) | Original data | Option 1 | Explanation to Option 1 | Option 2 | Explanation to Option 2 |
Sale in units (A) | 10000 | 12500 | Units increased by 2500 | 12500 | Units increased by 2500 |
Sale price (B) | 120 | 120 | - | 115 | Proposed sale price |
Sale value (A * B = C) | 1200000 | 1500000 | - | 1437500 | - |
Variable exp. @$80 per unit (A * 80 = D) | 800000 | 1000000 | - | 1000000 | - |
Contribution margin (C - D = E) | 400000 | 500000 | - | 437500 | - |
Fixed exp. (F) | 300000 | 315000 | $15000 increased | 300000 | - |
Operating income (E - F = G) | 100000 | 185000 | - | 137500 | - |
We can see that the operating income of option 1 is $ 185000 whereas that for option 2 is just $137500. No doubt, we must go with option 1.