Question

In: Economics

The following information is available for last month: Sales (10,000 units x $120 per unit)                           &n

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.

  1. Calculate the total operating income under each option above (1) and (2).
  2. Explain which option would you recommend from both a financial and a strategic perspective.

Solutions

Expert Solution

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.


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