Question

Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 83,000 units for $60 per unit. The variable production costs are $30, and fixed costs amount to $1,430,000. 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 $30 variable costs, 50 percent are from labor and 30 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 5 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 83,000 units, what price change would be required to attain the 8 percent increase in profits? Calculate the new price.

Answer 1

a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increas 38 39 40 Existing Proposed 41 60 66 (60*1.10%) 42 43 44 Selling Price Per Unit Less Variable expenses Direct Materials Per Unit (30*30%) Direct Labor Per Unit (30*50%) Variable Overheads Per Unit (30*20%) Variable expenses Per Unit Contribution Margin Per Unit (A) Total Number of Units (B) Total Contribution Margin (A*B) Less Fixed Costs Profit 9 15 6 30 45 46 47 48 49 9.9 (9*1.10) 18 (15*1.20) 7.5 (6*1.25) 35.4 30.6 30 83,000 2,490,000 1,430,000 1,060,000 50 1,501,500 (1430000*1.05) 51 52 53 Conribution Margin Ratio = Contribution Selling Price 54 55 56 30.60 66.00 57 58 59 Conribution Margin Ratio = 46.36%

62 Breakeven Point in Units Fixed expenses +Desired Profit Contribution Margin Per Unit 63 64 65 1501500 + 1060000 66 30.60 67 68 2561500 30.60 69 70 71 Breakeven Point in Units 83709 Units 72 73 break-even point in dollar sales Fixed expenses +Desired Profit Conribution Margin Ratio 74 1501500 + 1060000 46.36% 75 76 77 78 79 80 81 2561500 46.36% 82 break-even point in dollar sales 5,524,804

84 Volume in Units Sales 83,709 5,524,804 85 86 87 b. Compute the volume of sales and the dollar sales level necessary to provide the 8 percent increase in profits, assuming that the maxi 88 Existing Proposed 89 90 60 66 (60*1.10%) 91 9 92 93 94 15 6 Selling Price Per Unit Less Variable expenses Direct Materials Per Unit (30*30%) Direct Labor Per Unit (30*50%) Variable Overheads Per Unit (30*20%) Variable expenses Per Unit Contribution Margin Per Unit (A) Total Number of Units (B) Total Contribution Margin (A*B) Less Fixed Costs Profit 9.9 (9*1.10) 18 (15*1.20) 7.5 (6*1.25) 35.4 30.6 95 96 97 30 30 83,000 2,490,000 1,430,000 1,060,000 98 99 1,501,500 (1430000*1.05) 1,144,800 (1060000*1.08) 100 101

102 Conribution Margin Ratio = Contribution Selling Price 103 104 105 30.60 66.00 106 107 108 Conribution Margin Ratio = 46.36% 109 110 111 Breakeven Point in Units Fixed expenses +Desired Profit Contribution Margin Per Unit 112 113 114 1501500 + 1144800 115 30.6 116 117 2646300 30.60 118 119 120 Breakeven Point in Units = 86480 Units 121

122 break-even point in dollar sales Fixed expenses +Desired Profit Conribution Margin Ratio 123 124 125 1501500 + 1144800 126 46.36% 127 128 2646300 46.36% 129 130 131 break-even point in dollar sales 5,707,706 132 133 Volume in Units Sales 86,480 5,707,706 134 135

136 c. If the volume of sales were to remain at 83,000 units, what price change would be required to attain the 8 137 138 Let the new price be X 139 140 83000 *X-83000*35.4 - 1501500 1144800 141 142 83000 * X-2938200 - 1501500 1144800 143 144 83000 * X 1144800 +2938200 +1501500 145 146 83000 *X 5584500 147 148 х 5584500 83000 149 150 151 X 67.28 152 153 New Price 67.28 154