Question

Jim Jasons is thinking about starting a company to produce high performance video gaming computers. He loves playing video games. He sees it as an opportunity to be his own boss, making a living doing what he likes best. Jim paid $1,000 for training, and he has already purchased new equipment costing $10,000 to assemble the computers. He estimates that it will cost $750 in materials (case, monitor, keyboard, graphics card, CPU, etc.) to make each computer. If he decides to make computers full time, he will need to rent office and manufacturing space at an estimated $1,200 per month for rent plus another $300 per month for various utility bills. Jim would perform all the manufacturing and run the office, and he would like to pay himself a salary of $5,000 per month. Jim plans to hire two salespeople at a base salary of $1,500 each per month plus a commission of $100 per computer. Jim plans to sell each computer for $1,500. He believes that he can sell 50 computers in December for Christmas, but he is not sure what the sales will be during the rest of the year. However, he is sure that the computers will be popular because so many of his friends play video games. Overall, he is confident that he can pay all his business costs, pay himself, the monthly salary of $5,000 and earn at least $2,000 more than that per month. (Ignore income taxes.)

The following questions will help you analyze the information for this problem. Use Excel for all calculations and Microsoft Word for the written portion. One team member will submit one file in Canvas. You will be graded on accuracy and organization.

A. Preform analyses to estimate the number of computers Jim would need to manufacture and sell each year for his business to be financially successful:

1. List all the costs described and indicate whether each cost is (a) a relevant fixed cost, (b) a relevant variable cost, or (c) NOT relevant to Jim’s decision.

2. Calculate the contribution margin per unit and the contribution margin ratio.

3. Write down the total cost function for the computers and calculate the annual breakeven point in units and in revenues.

4. How many computers would Jim need to sell annually to earn $2,000 per month more than his salary?

B. Identify uncertainties about the CVP calculations:

1. Explain why Jim cannot know for sure whether his actual costs will be the same dollar amounts that he estimated. In your explanation, identify as many business risks as you can. (Hint: For each of the costs for Jim’s business that he has not identified, think about reasons why the annual cost might be different than the amount he estimated.)

2. Identify possible costs for Jim’s business that he has not identified. List as many additional types of cost as you can.

3. Explain why Jim cannot know for sure how many computers he will sell each year. In your explanation, identify as many risks as you can and discuss whether Jim is likely to be biased in his revenue and cost estimates.

4. Explain how business risk and Jim’s potential biases might affect interpretation of the breakeven analysis results.

PART A ANSWERED:

1.)

Relevant Fixed Costs Monthly: Rent $1,200, Various Utility Bills $300, Own Salary $5,000, Base salary for salespeople $3,000 (1500*2), Total Fixed Cost per month $9,500,

Relevant Variable Cost per unit: Cost of materials $750, Sales Commission $100, Total Variable Cost per unit $850

Not Relevant to the decision, Cost of trainning $1,000, Cost of Equipment $10,000, These are sunk cost, already incurred

CONTRIBUTION MARGIN Sales Price per unit $1,500 Variable cost per unit $850 Contribution Margin per unit=1500-850 $650 Contribution Margin Ratio=650/1500= 0.433333

3 TOTAL COST FUNCTION: TC=850Q+9500 TC=Total Cost Q=Quantity Sold

Breakeven Point in Units=Fixed Cost/Unit Contribution Margin Breakeven Point in Units=9500/650 14.61538 Rounded to whole number, Break even point in units 15 Break Even point in Revenue=$1500*15

$22,500 4 Net Earning =$2000 Number of Units to be sold=15+2000/650 =18

PLEASE JUST ANSWER PART B (BOLDED)

Answer 1

B. 1. The estimation of costs in business involves business risk due to the following reasons

· Actual inflation of cost budgeted can escalate the cost and actual amount can be higher than the budgeted amount

· Due to uncertainty and volatility involved in business the cost of conducting business can increase

· The peculiar nature of business can increase certain costs due to changes in regulations. For example: changes in import tariff can impact import related components price

· The demand and supply of components can affect the price and lead to increase in cost of input.

2. Possible costs for Jim’s business that are not listed

· Depreciation on facilities

· Repairs and maintenance

· Annual insurance

· Property taxes and license fees

· Office administrative cost

· Travel costs

· Cost incurred in developing business relations

· Research and development costs

· After sales service cost

· Advertising expenses.

3. Jim has calculated the estimated the market demand based on sales to his friends. The actual market of computers is ruled by established players in market. Hence Jim is biased in his revenue and cost estimates

The following are the factors which can affect the computer sales and risks is has

· High competition by the established players in the market

· Affect of new devices on the computers for example : tablets, mobile devices

· Consumer preference for branded computers

· After sales service offered by the manufacturer

4. As cost of conducting business will increase Jim needs to increase the computer units to be sold to ensure the breakeven point is achieved. But since Jim has not predicted the external market demand and sales that he can actually do in external market it can potentially impact the business model and can lead to losses because fixed costs needs to be incurred even if there is no sales or lower sales.