Question

Argentina Partners is concerned about the possible effects of inflation on its operations. Presently, the company sells 70,000 units for $55 per unit. The variable production costs are $30, and fixed costs amount to $800,000. Production engineers have advised management that they expect unit labor costs to rise by 20 percent and unit materials costs to rise by 5 percent in the coming year. Of the $30 variable costs, 60 percent are from labor and 15 percent are from materials. Variable overhead costs are expected to increase by 25 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 6 percent as a result of increased taxes and other miscellaneous fixed charges.

The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 7 percent during the year.

Required:

a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for "Volume in units" to the nearest whole number and round your answer for "Sales" to the nearest whole dollar amount.)

b. Compute the volume of sales and the dollar sales level necessary to provide the 7 percent increase in profits, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for "Volume in units" to the nearest whole number and round your answer for "Sales" to the nearest whole dollar amount.)

c. If the volume of sales were to remain at 70,000 units, what price increase would be required to attain the 7 percent increase in profits? Calculate the new price. (Round your answer to 2 decimal places.)

Answer 1

• All working forms part of the answer
• Working 1

A	Variable production cost per unit	$                   30.00
B=A x 60%	60% labor	$                   18.00
C = A x 15%	15% material	$                     4.50
D = A x 25%	25% variable overhead	$                     7.50

• Working 2: Current Situation (without inflation)

	Units	Per unit	Amount
sales	70000	$                             55.00	$      38,50,000.00
Labor cost	70000	$                             18.00	$      12,60,000.00
Material cost	70000	$                               4.50	$        3,15,000.00
Variable Overhead cost	70000	$                               7.50	$        5,25,000.00
Total variable cost	70000	$                             30.00	$      21,00,000.00
Contribution margin	70000	$                             25.00	$      17,50,000.00
Fixed Cost			$        8,00,000.00
Net Income			$        9,50,000.00

• Working 3: Current Situation and Inflation effects

	Current Year	Inflation effect
Sale Price	$                   55.00	$                             60.50
Labor cost	$                   18.00	$                             21.60
Material cost	$                     4.50	$                               4.73
Variable Overhead cost	$                     7.50	$                               9.38
Fixed Cost	$       8,00,000.00	$                 8,48,000.00
Net Income	$       9,50,000.00	$               10,16,500.00

• Requirement ‘a’

A	Maximum Increased price	$                   60.50
B	Labor cost	$                   21.60
C	Material cost	$                     4.73
D	Variable Overhead cost	$                     9.38
E=B+C+D	Total variable cost	$                   35.70
F=A-E	Unit Contribution margin	$                   24.80
G	Fixed Cost	$       8,48,000.00
H	Desired present level of Net Income	$       9,50,000.00
I= G+H	Total Contribution required	$     17,98,000.00
J = I/F	Volume in Units required	72500
K = J x A	Dollar Sales required to earn same profits level	$     43,86,250.00

• Requirement ‘b’

A	Maximum Increased price	$                   60.50
B	Labor cost	$                   21.60
C	Contribution margin	$                    4.73
D	Fixed Cost	$                     9.38
E=B+C+D	Total variable cost	$                   35.70
F=A-E	Unit Contribution margin	$                   24.80
G	Fixed Cost	$       8,48,000.00
H	Desired present level of Net Income	$     10,16,500.00
I= G+H	Total Contribution required	$     18,64,500.00
J = I/F	Volume in Units required	75181
K = J x A	Dollar Sales required to earn same profits level	$     45,48,478

• Requirement ‘c’

A	Sales revenue	70000x
B	variable cost [35.7 x 70000]	2499000
C	Fixed Cost	848000
D	Net Income desired	1016500
E = A - B -C = D	Sales revenue - variable cost - Fixed cost = Net desired income
	70000x - 2499000 - 848000 = 1016500
	70000x - 3347000 = 1016500
	70000x = 1016500 + 3347000
	70000x = 4363500
	x = 4363500 / 70000
	x = 62.34

Hence, New Sale price should be $ 62.34 per unit.

Old Sale price = $ 55

Increase in sale price = 62.34 – 55 = $ $7.34
% increase in sale price required = (7.34/55) x 100 = 13.35%