Question

Grosbeck Cattle Company has gathered the following information about operations for the past three years. Mathew Grosbeck has been expanding herd size and is frustrated that profits have not shown consistent growth.								Available	20
		Year 1	Year 2	Year 3				Your Score
	Cow herd size	120	140	180
	Revenues from sale of calves	$       102,000	$       119,000	$       153,000
	Feed	18,000	21,000	27,000
	Labor (1 cowboy per 120 cows)	24,000	48,000	48,000
	Cow depreciation	15,000	17,500	22,500
	Bull depreciation (1 bull per 30 cows)	1,667	2,083	2,500
	Medications/vaccinations	3,000	3,500	4,500
	Land lease	10,000	10,000	10,000
	Operating income	30,333	16,917	38,500
(a)	Determine which costs are variable, fixed, and "step" fixed. Complete the "per unit" cost table on the preprinted worksheet.
(b)	How much is the per-cow contribution margin?
(c)	How do the "step" costs explain the struggle to achieve consistent growth in profits? What strategy should Mathew undertake to maximize profit potential for his operation?
(d)	Assuming Mathew's land will support a herd of 240 cows, project anticipated profits.   Why is the profit more than twice as much as the amount that is earned on a herd size of 120 cows?

Answer 1

					Cost per unit
	Year 1	Year 2	Year 3	Year 1	Year 2	Year 3	Nature of Exp
Cow herd size	120	140	180	120	140	180
Revenues from sale of calves	102000	119000	153000	850.00	850.00	850.00
Feed	18000	21000	27000	150.00	150.00	150.00	Variable
Cow depreciation	15000	17500	22500	125.00	125.00	125.00	Variable
Medications/vaccinations	3000	3500	4500	25.00	25.00	25.00	Variable
Contribution	66000	77000	99000
Bull depreciation (1 bull per 30 cows)	1667	2083	2500	13.89	14.88	13.89	Step Fixed
Labor (1 cowboy per 120 cows)	24000	48000	48000	200.00	342.86	266.67	Step Fixed
Land lease	10000	10000	10000	83.33	71.43	55.56	Fixed Costs
Profit	30333	16917	38500
Profit %	30%	14%	25%
Description	Year 1	Year 2	Year 3
Sales	102000	119000	153000
Less : variable Cost	36000	42000	54000
Contribution	66000	77000	99000
Contribution per unit	550	550	550
Contribution margin	65%	65%	65%
Step Costs
This is a type of fixed cost that is only fixed within certain levels of activity. Once the upper limit of an activity level is reached then anew higher level of fixed cost becomes relevant.
In our case, One cowboy is required per 120 cows. Therefore, upto 120 cows, the cost is fixed, however, every single cow after that will bear this stepped fixed cost of $24000. As we can observe, although we have incurred labor cost for managing 240 cows, our herd size has not reached the level even after two years of operation. This under utilization of the labor resource directly hits our profit.
Similiarly 1 bull is required per 30 cows. Depreciation cost of a bull will increase in proportion to our herd size there by impacting our profit during increased operating levels.
If you want to improve the profit performance of your business, break even point analysissuggests that there are three main ways:
To increase sales volumes
To increase contribution rates
To reduce fixed costs
In order to nullify the impact of fixed costs, we need to increase the size of cow herd by atleast 65 thereby increasing revenue to maintain same level of profit.
Fixed Costs
labor	24000
land lease	10000
bull	1668
Contribution per unit	550
Breakeven (Cows)	65
Once we make the herd size to 121, our labor costs are commited to $24000 extra and we need o increase the herd atleast by 44 to nullify such extra/step fixed cost
	Anticipated
Cow herd size	240
Revenues from sale of calves	204000
Feed	36000
Cow depreciation	30000
Medications/vaccinations	6000
Contribution	132000	65%
Bull depreciation (1 bull per 30 cows)	3336
Labor (1 cowboy per 120 cows)	48000
Land lease	10000
Profit	70664
Profit %	35%
Since our Sales have increased in proportionate to the upper limit of step fixed cost per unit, we are anticipating profits. However, in order to sustain profits at this level, the next level of operation must be at 360 herd size.