Question

Problem: Letterman Office Service & Supply (LOSS) sells a variets of office equipment including the Executive office chair. The Executive sells for $250. Expected sales for next year are 6,000 units (sales estimates made by managemet are usually withing 10%) LOSS is considering a change in its manufacturing process. The accountants and engingeers have developed the followng two cost structures:

Current Manufacturing System: $175 variable cost per unit and $360,000 in fixed costs.

Alternate Manufacturing System: $75 variable cost per unit and $945,000 in fixed costs.

At what leve of sales will LOSS be indifferent between thetwo manufacturing plans?

Indifference Point in units:____________

What are the break-even points IN UNITS for the two maucaturing plans?

Current system breal-even:_________ Alternate system break-even:__________

What are the margins of safety of the two plans in units and precentages?

Current system MOS in units:___________ Alternate system MOS in units:___________

Current system MOS% :___________ Alternate system MOS%:___________

Which plan would you choose for LOSS? Why? What if sales are expected to increase? What if sales are expected to decrease?

Answer 1

Break even point(units): Fixed costs/Contribution margin per unit
MOS(units) = Profit/Contribution margin per unit
Current manufacturing system:
Breakeven point:
Contribution margin per unit = Selling price - Variable cost= $250-$175 = $75 per unit
Fixed costs = $360000
Break even point = $360000/$75 = 4800 units
Margin of safety:
Profit = Contribution - Fixed costs
= 6000*$75 - $360000
= $450000-$360000
= $90000
MOS(Units) = $90000/$75 = 1200 units
As a % = MOS(units)/Sales(Units) = 1200/6000 = 20%
Alternate manufacturing system:
Breakeven point:
Contribution margin per unit = Selling price - Variable cost= $250-$75 = $175 per unit
Fixed costs = $945000
Break even point = $945000/$175 = 5400 units
Margin of safety:
Profit = Contribution - Fixed costs
= 6000*$175 - $945000
= $1050000-$945000
= $105000
MOS(Units) = $105000/$175 = 600 units
As a % = MOS(units)/Sales(Units) = 600/6000 = 10%

Indifference point:
Change in fixed costs/Change in vaiable cost per unit
= $945000-$360000/$175-$75
= $585000/$100
= 5850 units.

So,
For LOSS, alternative manufacturing systems can be choses as they give much higher profits compared to current manufacturing system.
If the sales are expected to increase, more profits are generated under the alternative manufacturing system and the choice of plan seeks higher profits.
But if the sales are expected to decrease, till the breakeven point(5400) units, there will not be any losses incurred. But below 5400 units, losses may incur