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 82,000 units for $70 per unit. The variable production costs are $40, and fixed costs amount to $1,420,000. Production engineers have advised management that they expect unit labor costs to rise by 15 percent and unit materials costs to rise by 5 percent in the coming year. Of the $40 variable costs, 45 percent are from labor and 25 percent are from materials. Variable overhead costs are expected to increase by 20 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 6 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 6 percent increase in profits, assuming that the maximum price increase is implemented. c. If the volume of sales were to remain at 82,000 units, what price change would be required to attain the 6 percent increase in profits? Calculate the new price.

Answer 1

38 a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the max 39 40 Existing Proposed 41 70 77 (70*1.10%) 42 43 10 44 18 10.5 (10*1.05) 20.7 (18*1.15) 14.4 (12*1.20) 45.6 45 12 Selling Price Per Unit Less Variable expenses Direct Materials Per Unit (40*25%) Direct Labor Per Unit (40*45%) Variable Overheads Per Unit (40*30%) Variable expenses Per Unit Contribution Margin Per Unit (A) Total Number of Units (B) Total Contribution Margin (A*B) Less Fixed Costs Profit 46 40 47 31.4 48 49 30 82,000 2,460,000 1,420,000 1,040,000 1,491,000 (1420000*1.05) 50 51 52 53 54 55 Conribution Margin Ratio = Contribution Selling Price 56 57 58 31.40 77.00 59 Conribution Margin Ratio = 40.78%

62 Breakeven Point in Units 11 Fixed expenses +Desired Profit Contribution Margin Per Unit 63 64 65 1491000 + 1040000 66 31.4 67 68 2531000 31.40 69 70 71 Breakeven Point in Units = 80605 Units 72 73 break-even point in dollar sales Fixed expenses +Desired Profit Conribution Margin Ratio 74 75 76 1491000 + 1040000 77 40.78% 78 79 2531000 40.78% 80 81 82 break-even point in dollar sales 6,206,592

83 84 Volume in Units Sales 80,605 6,206,592 85 86 87 b. Compute the volume of sales and the dollar sales level necessary to provide the 6 percent increase in profits, assuming tha 88 89 Existing Proposed 90 70 77 (70*1.10%) 91 92 10 93 18 94 12 Selling Price Per Unit Less Variable expenses Direct Materials Per Unit (40*25%) Direct Labor Per Unit (40*45%) Variable Overheads Per Unit (40*30%) Variable expenses Per Unit Contribution Margin Per Unit (A) Total Number of Units (B) Total Contribution Margin (A*B) Less Fixed Costs Profit 10.5 (10*1.05) 20.7 (18*1.15) 14.4 (12*1.20) 45.6 31.4 95 96 40 30 97 98 82,000 2,460,000 1,420,000 1,040,000 99 1,491,000 (1420000*1.05) 1,102,400 (1040000*1.06) 100 101

Conribution Margin Ratio = 102 103 Contribution Selling Price 104 105 31.40 77.00 106 107 108 Conribution Margin Ratio = 40.78% 109 110 111 Breakeven Point in Units Fixed expenses +Desired Profit Contribution Margin Per Unit 112 113 114 1491000 + 1102400 115 31.4 116 117 2593400 31.40 118 119 120 Breakeven Point in Units = 82592 Units 121

122 break-even point in dollar sales Fixed expenses +Desired Profit Conribution Margin Ratio 123 124 125 1491000 + 1102400 126 40.78% 127 128 2593400 40.78% 129 130 131 break-even point in dollar sales 6,359,611 132 133 Volume in Units Sales 82,592 6,359,611 134 135

= = 36 c. If the volume of sales were to remain at 82,000 units, what price change would be required to attain the 6 percent increase in profits? 37 38 Let the new price be X 39 40 82000 * X - 82000 *45.6 - 1491000 1102400 41 42 82000 * X-3739200 - 1491000 1102400 43 44 82000 *X 1102400 +3739200 +1491000 45 46 82000* X 6332600 47 48 х 6332600 49 82000 50 51 х 77.23 52 53 New Price 77.23 54 =