Question

Problem#4 Great Grape Juice company is operating at full capacity. Annual revenues are $50,000,000. Total costs are $45,000,000, of which 40% is fixed and 60% is variable. In considering the following scenarios, assume each is independent of the others. (A) The company is considering expanding capacity. The additional capacity will add $10,000,000 in annual fixed costs. The contribution margin rate will not be impacted. How much inadditional sales will be necessary to justify the added capacity? (B)Assume a fungus has reduced grape production and increased total variable costs by an additional 10% of sales.Competitive pressures prevent Great Grape Juice from raising sales prices.Will the company remain profitable? (C) The company is considering automation of certain production processess.Productive capacity will not be increased, but the contribution margin ratio will increase by 5% of sales via a reduction in direct labor. The automated equipment will cost $5,000,000 per year to operate.Should the equipment be purchased? (D) the company is considering increasing the sales price per unit by 10%. The fixed costs and variable per unit cost will not be affected, but total sales volume (in units) will be reduced by 10%.Will the company be more or less profitable if they engage this pricing straregy?

Answer 1

Fixed Expense = 45000000*40% = $18000000

Profit = 50000000-45000000 = $5000000

Contribution Margin = Fixed Cost + Profit = 18000000+5000000 = $ 23000000

Contribution Margin Ratio = Contribution Margin/Total Revenue

= 23000000/50000000

= 46%

Answer A) Computation of Additional Sales for Expanding Capacity

Total Fixed Cost = Current Fixed Cost + Additional fixed cost

= 18000000 + 10000000

= 28000000

Total Contribution to maintain same profit = Fixed Cost + Profit

= 28000000 + 5000000

= 33000000

Total sales Require to earn Contribution = Contribution/Contribution Ratio

= 33000000/46%

= 71739130

Additional Sales = 71739130-50000000 = $ 21739130

To justfy added capacity Additional Sales of $ 21739130 is require.

Answer B)

If Company Maintain Current Level of Sales for increase variable cost then Profit is:

Additional Cost of Variable is = 10% of Sales = 50000000*10% = 5000000

Profit after Increase Variable Cost = Total Sales-Total Cost - Additional Variable Cost

= 50000000-45000000-5000000 =0

In current situation company not earning any profit or not getting any loss but if Company reduce the production of grapes then its decrease the sales and company will get loss in business.

Answer C) Profit after Investing in automated Equipment:

Current Contribution Margin =46%

Contribution Margin After automation = 51% (46+5)

Total Contribution Margin on sales = 50000000*51%

= 25500000

Profit = Contribution Margin -Fixed cost - Additional Cost

= 25500000-18000000-5000000 = $2500000

On implementation of strategy C profit will be reduce from $5,000,000 to $2,500,000.

Answer D)

Total Sales after increasing Sales price = (Current Sales + 10% of Current Sales)*90%

= (50,000,000+5,000,000)*90%

= $49,500,000

Current Variable Cost = 45,000,000*60% = 27,000,000

If sales decrease by 10% then Variabile cost also decrese by 10% ,

So Variable Cost = 27,000,000- (27,000,000*10%) = $24,300,000

Now Profit = 49,500,000-24,300,000-18,000,000

= $7,200,000

On implementing strategy D Profit will Increase by $2,200,000 (7,200,000-5,000,000).