Question

Describe how you would go about analyzing a make-or-buy decision when:

1. Your in-house production capability is not being used to full capacity.

2. You do not have the in-house production capability but could acquire it.

3. You have the in-house capability, but demand for its use exceeds full capacity.

Suppose a company has a contribution margin of 40 percent and total fixed costs of $3 million per year:

1. What is its break-even point in revenue?

2. If its fixed costs increase by 10 percent, and its contribution margin remains unchanged, by what percentage of revenue does its breakeven point increase?

3. By how much would its contribution margin increase if it could raise prices by 3 percent with no changes in variable or fixed costs?

Answer 1

question1.

Break-even revenue equals fixed costs divided by contribution margin ratio, which equals contribution margin divided by total revenue. The contribution margin is equal to the difference between revenue and variable costs

HERE GIVEN CONTRIBUTION MARGIN RATIO AS = 40%

CONTRIBUTION MARGIN / TOTAL REVENUE *100= 40%

BREAK EVEN POINT REVENUE = FIXED COST / CONTRIBUTION MARGIN

3/.40= = 7.5 MILLION IS BREAK EVEN REVENUE

question 2.

IF FIXED COST INCREASD BY 10% THEN FIXED COST WOULD BE =3.3 MILLION

BREAK EVEN SALES = 3.3/.40 = 8.25 HERE THE BREAK EVEN INCREASED BY 0.75 MILLION FROM THE PREVIOUS CASE % INCREASE = 8.25/7.5*100-100= 10%

QUESTION3.

HERE IN THE FIRST CASE

BREAK EVEN SALES 7.50 MILLION AND FIXED COSTS = 3 MILLION

SO THAT THE VARIABLE COST WOULD BE 7.50-3 = 4.50 (BECAUSE THERE IS NO PROFIT AND NO LOSS AT BREAK EVEN SALE SO THE DIFFERENCE IS VARIABLE COST)

HERE CONTRIBUTION MARGIN IS 3 MILLION = TOTAL REVENUE- VARIABLE COST

AND WHEN PRICE INCREASED BY 3% THE REVENUE WHILL BE = 7.725 MIllions (7.5+3% of 7.50)

Contribution margin will be = 7.725-4.50 = 3.225

% INCREASE = 3.225/3*100-100= 7.50%