Question

The following data is available for Milford Vinegar Co: Output level: (in units) 10,000 Bottles 15,000 20,000 Sales price per bottle: Variable production costs: Fixed production costs: Fixed selling and administrative costs: Total costs: 18.00 37,000 100,000 40,000 177,000 15.00 55,500 100,000 40,000 195,500 12.00 74,000 100,000 40,000 214,000 $ Requirements: 1. Prepare a contribution margin income statement for each level of production, include per unit detail 2. Assuming that the company will sell all output - At what level is profit maximized? 3. Calculate the break even point in dollar sales and units for each level of production 4. Analyze the pricing schedule that Milford is using - Why might Milford offer a lower customer price at higher production levels? 5. Management believes that by dropping the price to $10.50 per bottle and paying their sales staff a commission of 50 cents per bottle it can sell 24,000 bottles - Do you recommend this approach? Provide proof/support for your answer Explain what the management should be considering in making this decision?

Answer 1

1. Contribution margin Income statement :

When output is 10000

	Per unit	Total
Sales	$18	$180000
(-) variable cost	($3.7)	($37000)
Contribution margin	$14.3	$143000
(-) fixed cost :
Production cost		($100000)
Selling and administrative cost		($40000)
Net profit		$3000

Total sales amount = $18×10000 = $180000

Note 1 : calculations of variable cost per unit -

Variable cost per unit = total variable cost /number of units

= $37000/10000 units

= $3.7 per unit

When output is 15000

	Per unit	Total
Sales	$15	$225000
(-) variable cost	($3.7)	($55500)
Contribution margin	$11.3	$169500
(-) fixed cost :
Production cost		($100000)
Selling and administrative cost		($40000)
Net profit		$29500

Total sales amount = $15×15000 = $225000

When output is 20000

	Per unit	Total
Sales	$12	$240000
(-) variable cost	($3.7)	($74000)
Contribution margin	$8.3	$166000
(-) fixed cost :
Production cost		($100000)
Selling and administrative cost		($40000)
Net profit		$26000

Total sales amount = $12×20000 = $240000

2. Profit is maximised when 15000 units are sold.

As business makes maximum contribution margin at this level, it results in maximum net profit.

3.

Solution :

Break even point in units = total fixed cost /contribution margin per unit.

Break even in units at 10000 units = ($100000+$40000)/$14.3 = $140000/$14.3 = 9790.2 units

As units can't be decimals it is taken as 9791 units

Break even point in dollars = break even point in units × selling price per unit

Break even point in dollars at 10000 units = 9791 × $18 = $176238

Break even point in units at 15000 = $140000/$11.3 = 12389.4

It is taken as 12390 units

Break even in dollars = 12390 × $15 = $185850

Break even point in units at 20000 = $140000/$8.3 = $16867.5

It is taken as $16868 units.

Break even in dollars = 16868 × $12 = $202416

4. When production level increases there are more units of goods with the company to sell. In order to sell more units to the customers company reduces prices. When prices are reduced company can reach more customers. So, company reduced it's selling price when production levels increased.

5. This approach is not advisable, because even if 24000 units are sold the ultimate net profit is only $11200 which is less compared to the 15000 units option. So, this is not advised to do.

Solution :

Statement showing net income at 24000 units -

	Per unit	Total
Sales	$10.5	$252000
(-) variable cost	($4.2)	($100800)
Contribution margin	$6.3	$151200
(-) fixed cost :
Production cost		($100000)
Selling and administrative cost		($40000)
Net profit		$11200

Note 2: calculations of new variable cost per unit -

Variable cost per unit = $3.7 + $0.5 = $4.2