Saddam Toaster Co. is contemplating a modernization of its antiquated plant. It
ID: 1203786 • Letter: S
Question
Saddam Toaster Co. is contemplating a modernization of its antiquated plant. It now sells its toasters for $20 each; the variable cost per unit is $8, and fixed costs are $840,000 per year.
a. Calculate the break-even quantity.
If the proposed modernization is carried out, the new plant would have fixed costs of $1,200,000 per year, but its variable costs would decrease to $5 per unit.
b. What will be the break-even point now?
c. If the company wanted to break even at the same quantity as with the old plant, what price would it have to charge for a toaster?
d. If the new plant is built, the company would want to decrease its price to $19 to improve its competitive position. At which quantity would profits of the old and the new plants be equal? (assuming the price of a toaster is $20 for the old plant but $19 for the new)
e. How much would the profit be at this quantity?
f. If sales are projected to reach 150,000 units per year in the near future, would you recommend construction of the new plant? Why or why not?
Explanation / Answer
a. Break even qty = Fixed costs / contribution margin
Contribution margin in this case = 20 -8 = $ 12
so, break even qty = 840000/12 = 70,000 units
b. New fixed cost = $ 1,200,000 & new contribution margin = 20 -5 = $ 15
New break even qty = 1200000/15 = 80,000 units
c. Contribution margin (with old break even) = 1200000/70000 = $ 17.14
Adding the variable cost of $ 5, price = 17.14 + 5 = $ 22.14
d. say the qty is 'Q' units where both the profits would be equal
Q*12 - 840000 = Q*14 - 1200000......(12 is contribution for old scenario & 14 is contribution margin with new plant but price of $ 19)
therefore, 1200000 - 840000 = Q*2
Q = 180,000 units
e. Profit at this qty = $ 1,320,000
f. With 150,000 units,
profit in case 1 = 150000*12 - 840000 = $ 960,000
profit in case 2 = 150000*15 - 1200000 = $ 1,050,000
So, I would recommend construction of new plant
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