Delphi Company has developed a new product that will be marketed for the first t

Question

Delphi Company has developed a new product that will be marketed for the first time next year. The product will have variable costs of $18 per unit. Although the marketing department estimates that 35,000 units could be sold at $38 per unit, Delphi’s management has allocated only enough manufacturing capacity to produce a maximum of 25,000 units a year. The fixed costs associated with the new product are budgeted at $450,000 for the year. Delphi is subject to a 40% tax rate. 1.Calculate contribution margin per unit 2.How many units of the new product must Delphi sell in the next fiscal year to break even? 3.What is the maximum net income that Delphi can earn from sales of the new product in the next fiscal year? 4.Delphi’s managers have stipulated that they will not authorize production beyond the next fiscal year unless the after-tax profit from the new product is at least $75,000. How many units of the new product must be sold in the next fiscal year to ensure continued production?

Explanation / Answer

1.

The contribution margin per unit is the difference between the selling price per unit and variable cost per unit.

The selling price per unit is $38 and variable cost per unit is $18. The contribution margin per unit is as under:

Contribution margin per unit=S.P. per unit-V.C. per unit

=($38-$18)

=$20 per unit

2.

The break-even point in sales units is calculated by dividing fixed cost with the contribution margin per unit.

The fixed cost of the company is $450,000.

The break-even point in sales units=$450,000/$20

=22,500 units.

If the company sells 22,500 units, it will reach break-even point.

3.

The maximum number of units the company can produce in a year is 25,000. The maximum net income that Delphi company can earn is by the sale of 25,000 units is as under:

Sales (25,000*$38)                  $950,000

Less:

Variable cost (25,000*$18)      $450,000

Contribution margin                  $500,000

Less: Fixed cost                        ($450,000)

Income before tax                     $50,000

The maximum income before tax the company can earn in a year is $50,000.

4.

To earn $75,000 after tax income in a year the company has to make production of following number of units.

The tax rate is 40%. The income of $75,000 is equal to 60% (1-40%). The profit before tax would be $125,000 ($75,000/0.60).

The sales in units to earn profit of $75,000 after tax

= (Fixed cost + profit before tax)/contribution margin per unit

=($450,000+$125,000)/$20

=28,750 units

To earn $75,000 after tax income in a year the company has to make production of 28,750 units.

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