Question

6. Buffalo Company manufactures and sells adjustable canopies that attach to motor homes and trailers. For its budget, Buffalo estimated the following:

Selling price            $420

Variable cost per canopy    $205

Annual fixed costs       $180,000

Net Income            $250,000

Income Tax Rate        30%

The May financial statements reported that sales were not meeting expectations. For the first 5 months of the year, only 350 units had been sold at the established price with variable costs as planned. It was clear that the net income projection for the year would not be reached unless some actions were taken. A management committee presented the following mutually exclusive alternatives to the president:

A. Reduce the selling price by $40 per unit. The sales forecast that at this significantly reduced price is which 2,800 units can be sold during the remainder of the year. Total fixed costs and variable costs per unit will stay as budgeted.

B. Lower variable cost per unit by $10 through the use of less expensive direct materials and slightly modified manufacturing techniques. The selling price will also be reduced by $30 and sales of 2,200 units are expected for the remainder of the year.

C. Reduce fixed costs by $10,000 and lower the selling price by 5%. Variable costs per unit will be unchanged and sales of 2,000 units are expected for the remainder of the year.

Required:

(1) If no changes are made to the selling price or cost structure, determine the number of units that Buffalo must sell to break even and achieve its net income objective.

(2) Determine which alternative Buffalo should select to achieve maximum net income.

Answer 1

Solution:

Given data:
*Selling pric = $420
*Variable cost =$205
*Annual fixed costs = $1,80,000
*Net income =$2,50,000
*Income tax rae =30%

(1) : Determine of the number of units that Buffalo must sell to break even and achieve its net income objective.

Computation of Breakeven point:

Formula For Break Even Sales Units = Fixed Cost/Contribution margin per unit.

Sale Price = 420

Less:Variable Cost = (205)

Contribution = 215

Break even units = Fixed cost/contribution per unit
= 1,80,000 /215
= 837(Rounded off)

Therefore breakeven units = 837

At 837 units company will be able to recover its Total cost.Therefore, Any sale of units beyond this will give only income.

Number of more units to be sold to earn income objective is:

*Income to be earn = 2,50,000

*Per unit income = 215

* Units = 2,50,000/215

= 1,163 units (Rounded off)

Total units need to be sold = 837 + 1,163

= 2,000 units

Units sold till May = 350 units

Therefore, More units that need to be sold = 2,000-350

= 1,650 units

COMPUTATION OF INCOME AT EACH LEVEL:

(A) :

New Selling price = 380

Explanation: (Selling price reduced by $40 per unit ie.,420-40)
  
Varibale cost = 205

Fixed cost = 180
prepataion of Income Statement:

Sales ( 2800*380) =10,64,000

Sales ( 350*420) =1,47000

Therfore Total sales =12,11,000

Less:
Variable Cos(3150*205) =(645,750)

Contribution =5,65,250

Less: Fixed Cost = (1,80,000)

Total Income(Pre Tax) =3,85,250

Note: we have consider both sales till may at old price and Remaing sales at new price

(B):

New Selling Price = 390

Explanation: (selling price reduced by $30 per unit ie.,420-30)

New Variable Cost = 195(lower variable cost per unit by $10per unit ie., 205-10)

Fixed cost = 1,80,000

Sales (2200*390) =858,000

Sales ( 350*420) =147,000

Therfore Total Sales = 10,05,000

Less:

Variable Cost (350*205) = (71,750)

Variable Cost ( 2200*195) =(429,000)

Contribution Margin = 5,04,250

Less: Fixed Cost = (1,80,000)

Income =3,24,250

(C):

*New Selling Price = 399 (420-21)

Explanation: {Selling price reduced by 5% ie.,(405*5% =21)}

*Variable Cost = 205

   *New Fixed Cost = 1,70,000(Fixed cost reduced by 10,000 ie.,1,80,000-10,000)

Sales ( 2000* 399) = 7,98,000

Sales (350*420) = 147,000

Therefore Total Sales = 9,45,000

Less:
Variable Cost (2350*205) = (4,81,750)

Contribution Margin = 4,63,250

Less:
Fixed Cost =(1,70,000)

Income =2,93,250

(2):Determination of Which alternative shpuld select to achieve maximum net income by Buffalo-
Conclusion : Therefore Buffalo Sould select Option (A) that will generate Maximum Income to the Company.Therefore, it Must be choosen.