Question

Case: The Dial Company specializes in producing a set of wood patio furniture consisting of a table and four chairs. The set enjoys great popularity, and the company has ample orders to keep production going at its full capacity of 2,000 sets per year. Annual cost data at full capacity follow:

Direct labor ............ Advertising Factory supervision.. Property taxes, factory building .... Sales commissions .......... Insurance, factory ................. Depreciation, administrative office equipment ..... Lease cost, factory equipment ....... Indirect materials, factory ........... Depreciation, factory building. Administrative office supplies (billing) ... Administrative office salaries. Direct materials used (wood, bolts, etc.) ....... Utilities, factory ...... $118,000 $50,000 $40,000 $3,500 $80,000 $2,500 $4,000 $12,000 $6,000 $10,000 $3,000 $60,000 $94,000 $20,000

The patio sets are normally sold for $300 per set. Dial can increase capacity by 1,000 units to 3,000 units but must pay $25,000 to do so

Annual cost data for the production of 2,000 sets are classified as follows:

1. Please prepare a contribution margin income statement at normal capacity and label the income statement as Figure 1. Please show the following format and show columns for totals and per unit. Assume that sales are priced at the normal price.

  

2. Assume sales and demand for 2020 are 2,000 units, what would be the minimum price that you would charge if you wanted to make a profit. Why is this the correct price? Please explain your calculations and reference to the chart in Figure 1.   
3. If demand for 2020 is instead 3,000 units should the company pay to increase their capacity? Why? Please explain your calculations and reference to the chart in Figure 1. Assume units are sold at the normal price.

Hint: If you expand capacity, you will have to pay additional fixed costs of $25,000. Remember that fixed costs are fixed within the relevant range. If you expand capacity then you are outside this range. If you expand capacity then you can make revenue on 1,000 additional units and would pay variable costs on 1,000 additional units. Please consider the incremental profit or loss of expanding capacity. If the incremental profit of expanding capacity is positive then you should do so.

4. Assume sales and demand are 1,500 units, how much will the company make on the sale of the next unit (1,501^st)? Discuss which costs will change if the company makes and sells one more unit. Will the company make a profit on the unit if they sell at a price below your answer in 2? Please discuss your calculations and reference to Figure 1.

Answer 1

Figure 1
Contribution Margin Statement                                   (IN $)
				Total at 2,000 units	Per unit
Sales				600000	300
Less: Variable Costs
Direct labour			118000
Direct Material			94000
Sales Comission			80000
Indirect Materials			6000
Admin Office Supplies			3000
Utility Factory			20000	321000	160.5
Contribution				279000	139.5
Less: Fixed Costs
Advertising			50000
Factory Supervision			40000
Property and taxes			3500
Insurance, factory			2500
Depreciation, administrative office equipment			4000
Lease Cost, factory equipment			12000
Depreciation, factory building			10000
Administration Office Salary			60000	182000	91
Operating Income				97000	48.5

Assuming sales and demand for the product is 2,000 units, then the company should follow cost plus method. As per the chart given above, the total fixed cost per unit is $91 where as the variable cost per unit is $139.5, which totals to 251.5. Therefore the minimum price to cover all the costs is $251.5. The company can set any price higher than this to cover a profit.

It can be further explained through the following calculations:

Minimum price = Total costs / Total number of units

= 321,000+182,000 / 2000

= 251.5

Further, the company has an offer to increase the capacity by 1,000 units by incurring extra fixed cost of $25,000 which equals to $25 per unit and the contribution stands at $139.5 which is enough to cover for the additional cost. Hence, the company should consider increasing the capacity by incurring extra cost of $25,000.