Question

The Tasty Treats Factory plans to open a new retail store in Casper, Wyoming The store will sell specialty cupcakes for 55 per cupcake each cupcake has a variable cost of $4.) The company is nego for the new store. The landlord has offered to leasing options: 1) a lease of $2.500 per month or 2) a monte se cost of $1.700 plus of the company's monthly sales revenue Requirements 1. If the Tasty Treats Factory plans to sell 2000 cupcakes a month, which ease option would cost less each month? Why? 2. If the company plans to sell 4,000 cupcakes a month, which lease option would be more attractive? Why? Requirement 1. If the Tasty Treats Factory plans to sell 2.000 cupcakes a month, which lease option would cost less each month? Why? Begin by calculating the indifference point. Select the equation to determine the indifference point. (Abbreviations used FC - Fored costs, VCU Variable costs per unit) (VCU (option 1) x Units). FC option t) (VCU (option 2)x Units FC option 2) The indifference point is cupcakes

Answer 1

Summarized question:

Selling Price Per Unit = $6

Variable Cost Per Unit = $4

Option 1 : Pay fixed monthly lease rentals of $2600

Option 2 : Pay fixed monthly lease rentals of $1700 and variable rental based on sales revenue 5%.

Solution:

Calculation of indifference point :
Let's assume that indifference units be 'x'.

Comparing both the available options :
(VCpu*Assumed units) + Fixed Cost (Option 1) = (VCpu*Assumed Units) + Fixed Cost (Option 2)

=(4*x)+2600 = (4*x)+(6*0.05*x)+1700

=4x+2600 = 4x+0.3x+1700

=4x+2600 = 4.3x+1700

By transposing values;

4.3x-4x = 2600-1700

0.3x = 900

By transposing values;

x = 900/0.3

x = 3000 cupcakes

Therefore, indifference point is 3000 cupcakes.

Indifference point is the point where the costs incurred/profits earned by the entity in both the given situations are same.

As we are aware that the Variable cost per unit remains constant at all levels while the absolute amount (expense) changes with the change in volume but the fixed cost expense remains the same at all levels of output, however, the fixed cost per unit changes with the increase in a marginal unit.

Based on the above statement we can develop a range, which can depict that at what level which option can be preferred. Indifference point of 3000 cupcakes will serve as the base.

Range:

If units are less than 3000 cupcakes = It is better to use Option 2 as this will result in lower outflow as it has the mixture of variable and fixed component, out of which variable portion will remain constant.

If units are 3000 cupcakes = Indifferent

If units are more than 3000 cupcakes = It is better to use option 1 of fixed lease rentals as that would result in lower cost per unit and hence will maximize the profits.

Check :

INCOME STATEMENT
	Option 1		Option 2
Particulars/Units	2000	4000	2000	4000
Sales at $6 per unit	12000	24000	12000	24000
Variable cost at $4 per unit	-8000	-16000	-8000	-16000
	4000	8000	4000	8000
Lease Rentals	-2600	-2600	-2300	-2900
Profits	1400	5400	1700	5100

Computation of Lease Rentals :

@2000 level = $1700 (Fixed) + (5% of 12000)

= $2300

@4000 level = $1700 (Fixed) + (5% of 24000)

= $2900

Therefore, the above computation makes this clear that we should opt for Option 2 where units are 2000 basis the reason mentioned above.
Also, the option 1 of fixed rentals would be preferred if the units turn out to be 4000, as this would spread the fixed cost over large number of units and in turn, reduce per unit cost.