Question

Luke Corporation produces a variety of products, each within their own division. Last year, the managers at Luke developed and began marketing a new chewing gum, Bubbs, to sell in vending machines. The product, which sells for $5.70 per case, has not had the market success that managers expected and the company is considering dropping Bubbs.

The product-line income statement for the past 12 months follows:

Revenue				$	14,695,650
Costs
Manufacturing costs	$	14,444,895
Allocated corporate costs (@5%)		734,783			15,179,678
Product-line margin				$	(484,028	)
Allowance for tax (@20%)					96,805
Product-line profit (loss)				$	(387,223	)

All products at Luke receive an allocation of corporate overhead costs, which is computed as 5 percent of product revenue. The 5 percent rate is computed based on the most recent year’s corporate cost as a percentage of revenue. Data on corporate costs and revenues for the past two years follow:

	Corporate Revenue		Corporate Overhead Costs
Most recent year	$	115,750,000	$	5,787,500
Previous year	$	77,100,000		4,929,470

Roy O. Andre, the product manager for Bubbs, is concerned about whether the product will be dropped by the company and has employed you as a financial consultant to help with some analysis. In addition to the information given above, Mr. Andre provides you with the following data on product costs for Bubbs:

Month	Cases	Production Costs
1	216,000	$1,155,340
2	221,700	1,176,840
3	219,400	1,185,493
4	237,000	1,201,035
5	224,950	1,203,339
6	246,000	1,224,185
7	224,750	1,199,211
8	251,700	1,242,286
9	243,300	1,240,738
10	257,150	1,252,837
11	254,700	1,257,272
12	263,700	1,287,963

Required:

a. Bunk Stores has requested a quote for a special order of Bubbs. This order would not be subject to any corporate allocation (and would not affect corporate costs). What is the minimum price Mr. Andre can offer Bunk without reducing profit any further? (Round your answer to 2 decimal places.(i.e., 32.21))

b. How many cases of Bubbs does Luke have to sell in order to break even on the product? (Round variable cost percentage to 2 decimal places, fixed costs to whole dollar amount and profit per case to 3 decimal places for intermediate calculations. Round your final answer up to the nearest whole unit.)

c. Suppose Luke has a requirement that all products have to earn 5 percent of sales (before tax after corporate allocations) or they will be dropped. How many cases of Bubbs does Mr. Andre need to sell to avoid seeing Bubbs dropped? (Round your minimum price per case to 2 decimal places and do not round your other intermediate calculations. Round your final answer up to the nearest whole unit.)

d. Assume all costs and prices will be the same in the next year. If Luke drops Bubbs, how much will Luke’s profits increase or decrease? Assume that fixed production costs can be avoided if Bubbs is dropped. (Use variable cost percentage to 2 decimal places. Round intermediate calculations and final answers to nearest whole dollar amount.)

Answer 1

Part A

Minimum price

$2.22 per case

Relevant cost = variable cost production cost (X variable coefficient in Regression summary output)

Part 2

Break-even point

205398 cases

Variable cost = (cost at highest activity – cost at lowest activity)/(highest activity-lowest activity) = (5787500-4929470)/(115750000-77100000) = 2.22%

Profit = revenues – variable product costs – variable corporate costs – fixed product costs

0= 5.70Q-2.22Q-(2.22%*5.70Q)-688794

3.35346Q = 688794

Q = 205398

Part 3

Break-even point

236292 cases

Profit = revenues – variable product costs – variable corporate costs – fixed product costs

0= 5.70Q-2.22Q-(5%*5.70Q)-688794

3.195Q = 688794

Q = 215585

Part 4

Profit

$67445 increases

Lost revenue	(14695650)
Product costs avoided	14444895
Loss before corporate overhead savings	(250755)
Corporate costs avoided (14695650*2.28%)	335061
Increase profits before tax	84306
Tax @ 20%	16861
Increased profits	$67445