Question

Argentina Partners is concerned about the possible effects of inflation on its operations. Presently, the company sells 65,000 units for $30 per unit. The variable production costs are $16, and fixed costs amount to $750,000. Production engineers have advised management that they expect unit labor costs to rise by 20 percent and unit materials costs to rise by 10 percent in the coming year. Of the $16 variable costs, 45 percent are from labor and 20 percent are from materials. Variable overhead costs are expected to increase by 25 percent Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 6 percent as a result of increased taxes and other miscellaneous fixed charges. The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 8 percent during the year Required: a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented b. Compute the volume of sales and the dollar sales level necessary to provide the 8 percent increase in profits, assuming that the maximum price increase is implemented. c. If the volume of sales were to remain at 65,000 units, what price increase would be required to attain the 8 percent increase in profits? Calculate the new price.

Answer 1

Solution of the above problem is as under:

a) Computation of volume in units and the dollar sales level necessary to maintain present profit level, assuming maximum price increase is implemented.

We know, Profit = (Sale Price per unit -Variable Cost per unit)*Units minus Fixed Cost.

Present Profit (in dollars)= $(30-16)*65000 units - $750000

=$14*65000 Units -$750000= $( 910000-750000)=$ 160000 (Present Profit)

New Variable Cost per Unit:

Particulars	Old	Increase in Cost as advised by Production Engineer	New
Variable Cost per Unit	16		19.16
Labour Cost per Unit (45% of Variable cost per unit)	7.2	120%	8.64
Material Cost per Unit (20% of Variable Cost per Unit)	3.2	110%	3.52
Variable OH Cost (remaining 35%)	5.6	125%	7

Increase in Sale Price = $30 X 110% =$33

Increase in Fixed Cost as per Question = $750000 X 106% = $795000

Sales required to Maintain Present Profit:

Profit = (Sales Price per Unit - Variable Cost per Unit ) * Units minus Fixed Cost

Let Units required to maintain profit be X

thus, $160000 = $(33-19.16)*X-$795000

= $955000 = $13.84X

This implies, X= 69002.89 Units.

This means, 69002.89 Units must be sold to maintain atleast present level of profit of $ 160000.

Dollar Sales Level : 69002.89 Units * $33 = $ 2277095.37

This means, sales of $ 2277095.37 would be needed to maintain a profit of $ 160000.

b) Computation of volume in units and the dollar sales level necessary to provide 8 percent increase in profit, assuming maximum price increase is implemented.

Desired Profit Increase : $ 160000 X 108% = $ 172800

Sales required to gain increased profit:

Profit = (Sales Price per Unit - Variable Cost per Unit )* Units Minus Fixed Cost

This implies, $172800 = $(33-19.16)*X-$795000

= $967800 = $ 13.84 X

thus, X= 967800/13.84= 69927.75 Units

Dollar Sales Level: $33 X 69927.75 Units

=$ 2307615.75

c) If Volume of sales to be maintained at 65000 units, new sale price to achieve the 8 percent increase in present profit is:

Let New Sale Price per Unit be $X

Now, we know, Profit = (Sale Price per Unit- Variable Cost per Unit) * Units minus Fixed Cost

i.e. $172800 = 65000X- ($19.16 * 65000) - $ 795000

this implies, 65000X = 172800 + 795000 + 1245400

=X = 2213200/65000

Thus, X= $ 34.05

New Sale price per unit = $ 34.05