Question

Number 5 Birchfield Company reports the following operating results for the month of February: sales $900,000 (units 15,000): variable costs $472,500; and fixed costs $202,500. Management is considering the following independent courses of action to increase net income. Increase selling price by 2.5% with no change in total variable costs or units sold. Reduce variable costs to 49% of sales. 2. Instructions Compute the net income to be earned under each alternative. Which course of action will produce the highest net income? (a) (b) Birchfield's management is looking at longer term solutions to improve net income. One of the options they have reviewed will increase fixed expenses by $27.500 while reducing variable expenses by $2 per unit. Management feels that with these changes the price of the product could be reduced by $1 per unit. The decrease in price will then result in an increase in unit sales of 5% Compute the net income to be earned under this alternative. Do you recommend this option? Why or why not?

Answer 1

Solution a:

The current situation of Birchfield Company

	Total $ (15,000 Units)	Per Unit $
Sales	9,00,000.00	60.00
Less: Variable Cost	4,72,500.00	31.50
Contribution = Sales – Variable Cost	4,27,500.00	28.50
Less: Fixed Cost	2,02,500.00
Income from Operations = Contribution – Fixed Cost	2,25,000.00

Alternative 1) Increase in selling price by 2.5% with no change in total variable cost or units sold.

New Selling price = $60 + 2.5% = $61.5

	Total $ (15,000 Units)	Per Unit $
Sales	9,22,500.00	61.50
Less: Variable Cost	4,72,500.00	31.50
Contribution	4,50,000.00	30.00
Less: Fixed Cost	2,02,500.00
Income from Operations	2,47,500.00

Alternative 2) Reduce Variable Costs to 49% of Sales:

New Total Variable Cost = 49% of $900,000 = $441,000

	Total $ (15,000 Units)	Per Unit $
Sales	9,00,000.00	60.00
Less: Variable Cost	4,41,000.00	29.40
Contribution	4,59,000.00	30.60
Less: Fixed Cost	2,02,500.00
Income from Operations	2,56,500.00

The company is recommended to go with the second alternative i.e reducing the variable cost to 49% of sales as it will increase the Income from Operation to $256,500 which is higher than the first alternative by $9,000 ($256,500 - $247,500).

Solution b) New Fixed Cost = $202,500 + $27,500 = $230,000

New Variable Cost per unit = $31.50 - $2.00 = $29.50

New Selling Price = $60.00 - $1.00 = $59.00

New Sales (Units) = 15,000 + 5% = 15,750 Units

	Total $ (15,750 Units)	Per Unit $
Sales	9,29,250.00	59.00
Less: Variable Cost	4,64,625.00	29.50
Contribution	4,64,625.00	29.50
Less: Fixed Cost	2,30,000.00
Income from Operations	2,34,625.00

The Birchfield Management is recommended to go with this option as it will increase the Net Income by $9,625 ($2,34,625 - $2,25,000.00).