Question

Question 5 ABC Company plans to sell 100,000 units of its single product X, in a period at a selling price of $15 per unit. Fixed overheads and net profit for the period are expected to be $440,000 and $520,000 respectively using the existing production process. The company is considering a change to its production process. The change would increase the fixed overheads to $700,000 in the period and reduce the variable costs to $3.5 per unit. The selling price will remain constant regardless of production process. Production capacity in both existing and changed processes would be 150,000 units in the period.

Required:

(a) For the existing production process, calculate breakeven point in units and sales dollars.

(b) Advise management, using supporting calculations, of the sales level (units) at which the changed process would become more profitable than existing process. Explain the rationale with appropriate examples.

(c) Refer to information of the existing production process, assume the company proposes to produce an additional 50,000 units of a new product, namely product Y. The selling price of product Y is $10 per unit and variable cost is $5 per unit. Compute the number of units and sales dollars for product X and product Y to breakeven in the new sales mix. What advice would you give to the company based on the proposal?

(d) Discuss why CVP analysis may not be applicable to a variety of situations.

Answer 1

(a)

Break even point in units=Fixed Cost/(Unit Contribution)

Total Fixed costs=$440,000

Net Profit =$520,000=Total Sales Revenue-Total Variable Costs -Fixed Costs

Total Contribution =(Total Sales Revenue-Total Variable Costs)=Net Profit+Fixed Costs =$520,000+$440,000

Total Contribution =$960,000

Unit Contribution =960000/100000=$9.6

Break Even Point in Units =Fixed Cost/(Unit Contribution)=440000/9.6=45,833

Break even point in sales dollar=45833*$15=$687,495

(b)Changed Process:

Contribution per unit =Sales Price -Variable cost=$15-$3.5=$11.5

Fixed Costs=$700,000

Break Even Point in Units =Fixed Cost/(Unit Contribution)=700000/11.5=60,870

At Sales Level above 60870 , the new process will give more contribution per unit

Assume Number of Units at which both process having same net profit =N

Profit of old process =Contribution -Fixed Cost =N*9.6-440000

Profit of NEW  process =Contribution -Fixed Cost =N*11.5-700000

If these= are equal :

N*9.6-440000=N*11.5-700000

N*(11.5-9.6)=700000-440000=260000

N*1.9=260000

N=260000/1.9=136,842

At Sales Level 136,842 , the NEW process will be more profitable

(c) PRODUCT MIX:

Product X=100000/(100000+50000)=2/3

Product Y=50000/(100000+50000)=1/3

Weighted average Contribution Margin =(2/3)*9.6+(1/3)*(15-10)=$8.07

Fixed Costs of existing process=$440,000

Break Even point in units=440000/8.07=54523

Break Even Point of Product X=(2/3)*54523=36,349

Break Even Point of Product Y=(1/3)*54523=18,174

After meeting the demand of Product X, if capacity is available , management can produce Product Y

(d) CPV analysis may not be available in various situations:

1. The cost function may not be linear

2. Fixed costs may not remain fixed at all levels

3. Sales Price per unit may not be constant at all levels