Question

Dreamland Pillow Company sells the Old Softy model for $20 each. One pillow needs two pounds of raw material as well as one hour of direct labour to manufacture. Raw material costs $3 per pound as well as direct production labour is paid $4 per hour. Fixed supervisory costs are $2000 per month as well as Dreamland rents its factory on a five-year lease for $4,000 per month. All costs are deliberated costs of production. How many pillows should Dreamland produce and sell each month to earn a monthly gross profit of $1,000?

Another firm has offered to produce ?"Old Softy" pillows and sell then to Dreamland for $12 each. Dreamland cannot avoid the factory lease payments, but can avoid all labor cost if it does not produce these pillows. Under these conditions, how many "Old Softy" pillows must Dreamland sell to earn montly gross profits of $1000?

(A.) 300 (b) 350 (c) 600 (d) 700

Answer 1

Concepts and reason

Marginal costing: It is technique of costing wherein variable cost is charged to production and fixed cost is deducted from contribution margin.

Gross profit: The profit earned after reducing fixed expenses from contribution margin is the gross profit. The fixed expenses deducted are those related to cost of production.

Fundamentals

Variable cost: These costs are directly related to the volume of production of the company. With the increase in production variable cost also increases and vice versa. However, the total variable cost changes but per unit variable cost remains same. Such costs are considered for any decision making as they are directly related to the production. Examples of variable cost are direct material cost, direct labor cost, freight, etc.

Fixed cost: Fixed cost is incurred by the company only once during the period. It is also referred to as period cost. It does not vary with the production of the company. The total fixed cost incurred remains same irrespective of the production but per unit fixed cost changes with the production. Examples of fixed costs are salaries, marketing, rent, etc.

Calculate the variable cost per unit as shown below:

Compute the fixed cost as shown below:

$\begin{array}{c}\\{\rm{Fixed cost}} = \$ 2,000 + \$ 4,000\\\\ = \$ 6,000\\\end{array}$

The per unit variable cost is $12

The total fixed cost is $4,000.

Ans:

The number of pillows Dreamland should produce and sell each month to earn monthly gross profit of $1,000 is 700 pillows

The number of pillows Dreamland should produce and sell each month to earn monthly gross profit of $1,000 is 625 pillows