Question

QUESTION 2 (5 Marks) Dunning Ltd. manufactures a popular power nail gun suitable for the home renovator. Financial and other data for this product for the last twelve months are as follows: Sales 20,000 units Selling price $130 per unit Variable manufacturing cost $50 per unit Fixed manufacturing costs $400,000 Variable selling and administrative costs $30 per unit Fixed selling and administrative costs $300,000 The directors of Dunning Ltd. want to try to increase the profitability of this product and invited senior staff to suggest how this might be done. Three suggestions have been received. • The accountant, Jim Jackson, believes that a price increase of $10 per unit is the best way to boost profits. He would spend an additional $125000 on national advertising and contends, that if this is done, sales volume would not drop appreciably from last year. The production manager, Tim Walter, thinks that an improved quality product could increase sales volume by 25% if accompanied by an advertising campaign costing $50000 aimed at tradespeople as well as home renovators. The improved quality would add $5 per unit to the variable cost. Mr Walter believes that the price should not be increased. The sales manager, Sandy Smith, wants to undertake a promotion campaign where a $10 rebate is offered on all nail guns sold during the three months beginning 1 April. Normally 6000 units are sold during that period and Ms Smith believes that this could be boosted to 10,000 units if an advertising campaign costing $40,000 were launched late in March. You have been asked by the Dunning board to comment on each of these three proposals. Draft a report in response to this request. You are not asked to make an outright choice, but rather to analyse the potential strengths and weaknesses of each proposal by calculating break-even point. The sales volumes forecast by each staff member should be treated as estimates only and your report should examine the effects of variations in actual sales from these forecasts and its respective break-even point. Show your calculations to support your comments and mention qualitative factors that may also be involved.

Answer 1

Ans. Calculation of Current Break-even point:

Total Fixed Costs = $400,000 + $300,000 = $700,000

		Amount
	Selling Price	$130
Less:	Variable Manufacturing Costs	$50
Less:	Variable Selling and Administrative Costs	$30
	Contribution per unit	$50

Therefore, Break-even = Total Fixed Cost / Contribution per unit = $700,000 / $50 = 14,000 units or $1,820,000 (Sale Value)

Calculation of Break-even point for Accountant's Proposal:

Total Fixed Costs = $400,000 + $300,000 + $125,000 = $825,000

		Amount
	Selling Price	$140
Less:	Variable Manufacturing Costs	$50
Less:	Variable Selling and Administrative Costs	$30
	Contribution per unit	$60

Therefore, Break-even = Total Fixed Cost / Contribution per unit = $825,000 / $60 = 13,750 units or $1,925,000 (Sale Value)

Calculation of Break-even point for Production Manager's Proposal:

Total Fixed Costs = $400,000 + $300,000 + $50,000 = $750,000

		Amount
	Selling Price	$130
Less:	Variable Manufacturing Costs	$55
Less:	Variable Selling and Administrative Costs	$30
	Contribution per unit	$45

Therefore, Break-even = Total Fixed Cost / Contribution per unit = $750,000 / $45 = 16,667 units or $2,166,710 (Sale Value)

Calculation of Break-even point for Sales Manager's Proposal:

Total Fixed Costs = $400,000 + $300,000 + $60,000 + $40,000 = $800,000

		Amount
	Selling Price	$130
Less:	Variable Manufacturing Costs	$50
Less:	Variable Selling and Administrative Costs	$30
	Contribution per unit	$50

Therefore, Break-even = Total Fixed Cost / Contribution per unit = $800,000 / $50 = 16,000 units or $2,080,000 (Sale Value)

Since the break-even point is least in current scenario, the management should continue its current practice.