Question

Riveria Co. makes and sells a single product. The current selling price is $38 per unit. Variable expenses are $19 per unit, and fixed expenses total $37,000 per month. Sales volume for May totaled 4,760 units.

Required:

1. Calculate operating income for May.
2. Calculate the breakeven point in terms of units sold and total revenues.
3. Management is considering installing automated equipment to reduce direct labor cost. If this were done, variable expenses would drop to $13 per unit, but fixed expenses would increase to $61,600 per month.

1. Calculate operating income at a volume of 4,760 units per month with the new cost structure.
2. Calculate the breakeven point in units with the new cost structure.
3. Why would you suggest that management seriously consider investing in the automated equipment and accept the new cost structure?
4. Why might management not accept your recommendation but decide instead to maintain the old cost structure?

Answer 1

Calculate operating income for May.

Operating income = Sales - Variable expenses - fixed expenses

Sales (4,760 * $38) = $180,880

Variable expenses (4,760 * $19) = $90,440

Operating income = $180,880 - $90,440 -  $37,000

= $53,440

Calculate the breakeven point in terms of units sold and total revenues.

Break even point in units = Fixed expenses / Contribution margin per unit

= $37,000/ ($38 -$19)

= 1,947 units

Contribution margin per unit = selling price - variable expenses per unit

Break even point in revenue = Fixed expenses /Contribution margin ratio

= $37,000 / 0.50

= $74,000

Contribution margin ratio = ($38 - $19) / $38

= 0.50

Calculate the breakeven point in units with the new cost structure.

Variable cost = $13

Fixed expenses = $61,600

Operating income = Sales - Variable expenses - fixed expenses

Variable expenses (4,760 * $13) = $61,880

Operating income = $180,880 - $61,880 - $61,600

= $57,400

Calculate the breakeven point in units with the new cost structure.

Breakeven point in units = Fixed expenses / Contribution margin per unit

= $61600 / ($38 - $13)

= 2,464 units

Management seriously consider investing in the automated equipment and accept the new cost structure because operating income arises in new cost structure.