Question

Read each question carefully! Make sure that you answered each part of all of the questions. Write your answers on the exam and attach any schedules or spreadsheets where necessary. Good Luck! Problem #1: CVP Basics Payne Co. sells shoes which are made in the USA. Current data for the last month was as follows: Average Selling Price $100 Variable Cost Per Unit $60 Monthly Fixed Costs. $90,000 Units Sold 4,000 Payne has a target net income of $50,000 Payne has an opportunity to shift production overseas. The overseas manufacturer would charge a monthly charge of $175,000 to make all of the shoes thus eliminating the variable costs. Payne would still have the fixed costs listed above as well as the new manufacturing fixed costs. Required Complete the chart below with the original data as well as if the changes are made. Current Situation With Changes Cost Per Unit Net Income Break-Even in Units Units for Net Income of $50,000 What should Payne do? Consider non-financial aspects as well as the changes in accounting data.

Answer 1

Answer (a):

Current situation:

Cost per unit = 60 + 90000 / 4000 = $82.50

Net Income = Contribution margin - fixed cost = (100 - 40) *4000 - 90000 = $70,000

Break-even in units = Fixed cost / Contribution per unit = 90000 / (100 - 60) = 2,250

Units for net income of $50,000 = (90000 + 50000) / (100 - 60) = 3,500 units

With Changes:

Variable cost = $0

Fixed costs = 175000 + 90000 = $265,000

Cost per unit = 265000 / 4000 = $66.25

Net Income = Contribution margin - fixed cost = (100 - 0) *4000 - 265000 = $135,000

Break-even in units = Fixed cost / Contribution per unit = 265000 / (100 - 0) = 2,650

Units for net income of $50,000 = (265000 + 50000) / (100 - 0) = 3,150 units

Cost per unit Net Income Break-Even in units Units for net income of $50,000 Current Situation with Changes $82.50 $66.25 $70,000 $135,000 2,250 2,650 3,500 3,150

Answer (b):

Let us first evaluate the financials:

If Payne can sell 4,000 units, "with changes' net income increases from $70,000 to $135,000

Further it need to sell less units (with changes) to earn net income of $50,000

However:

With increase in fixed costs, its break-even units, with changes, increases from 2,250 units to 2,650 units

Hence:

Although 'with changes' its net income increases, it runs the risk of higher losses if for any reason its sales are less than 2,650 units.

Non-financial aspects:

'With changes' it is shifting production overseas, hence it is exposed to additional risks like country risks, foreign exchange risks. These risks need to be factored into evaluations.

It will also loose control over productions; hence it may face risks as regard to quality, reliability of deliveries. Any adverse happening on these will result in losing customers / potential customers, loss of reputation/brand image.

Considering both financial and non-financial factors it is advisable for Payne to maintain current situation.