Question

Problem 18-6A Analysis of price, cost, and volume changes for contribution margin and net income P2 @ A1 This year Burchard Company sold 40,000 units of its only product for $25 per unit. Manufacturing and selling the product required $200,000 of fixed manufacturing costs and $325,000 of fixed selling and administrative costs. Its per unit variable costs follow. Material Direct labor (paid on the basis of completed units) Variable overhead costs Variable selling and administrative costs $8.00 5.00 1.00 Next year the company will use new material, which will reduce material costs by 50% and direct labor costs by 60% and will not affect product quality or marketability. Management is considering an increase in the unit selling price to reduce the number of units sold because the factory's output is nearing its annual output capacity of 45,000 units. Two plans are being considered. Under plan 1, the company will keep the selling price at the current level and sell the same volume as last year. This plan will increase income because of the reduced costs from using the new material. Under plan 2, the company will increase the selling price by 20%. This plan will decrease unit sales volume by 10%. Under both plans 1 and 2, the total fixed costs and the variable costs per unit for overhead and for selling and administrative costs will remain the same.

Answer 1

1) Break Even Point in Dollars = Total Fixed Cost/Contribution Margin Ratio

Calculation of Break Even Point in Dollars (Amounts in $)

	Plan 1 (a)	Plan 2 (b)
i) Revised Material cost per unit [8*(1-50%)]	4.00	4.00
ii) Revised direct labor cost per unit [5*(1-60%)]	2.00	2.00
iii) Variable overhead costs	1.00	1.00
iv) Variable selling and administrative costs	0.50	0.50
v) Total Variable cost [(i)+(ii)+(iii)+(iv)]	7.50	7.50
vi) Selling Price per unit	25.00	30.00 (25*1.20)
vii) Contribution Margin per unit [(vi) - (v)]	17.50	22.50
viii) Contribution Margin Ratio [(vii/vi)*100]	70%	75%
ix) Total Fixed Cost (200,000+325,000)	525,000	525,000
x) Break Even Sales in Dollars (ix/viii)	750,000	700,000

2) Forecasted Contribution Margin Income Statement is shown as follows (Amounts in $)

	Plan 1	Plan 2
a) Sales	1,000,000 (40,000*$25)	1,080,000 (40,000*90%*$30)
b) Total Variable Costs	300,000 (40,000*$7.50)	270,000 (40,000*90%*$7.50)
c) Contribution Margin (a-b)	700,000	810,000
d) Total Fixed Costs	525,000	525,000
e) Income before taxes (c-d)	175,000	285,000
f) Income taxes (e*30%)	52,500	85,500
g) Net Income (e-f)	122,500	199,500