Sound Eleven Corporation produces electric guitars. Their “High Volume” style gu

Question

Sound Eleven Corporation produces electric guitars. Their “High Volume” style guitars are mainly used for students and guitar players looking for an inexpensive practice guitar. The cost of manufacturing and marketing their guitars, at their normal factory volume of 5,000 “High Volume” guitars per month, is shown in the table below. These guitars sell for $350 each.

(Note: Fixed costs are shown on a per-unit basis in the table based on normal volume. However, fixed costs as a total do not change when volume changes, so you will need to determine total fixed costs first.)

Question 1: What is the break-even point? A) In units? B) In sales dollars?

Question 2: A nearby music school has offered to purchase 3,000 guitars (one time) if the price was lowered to $300 per guitar. Sound Eleven’s maximum capacity is 6,000 units. A) Based on the cost data provided, what would be the impact of the price decrease on sales, costs, and operating income if Sound Eleven accepted this sale? B) Do you think Sound Eleven should accept this sale? Support your decision with evidence and analysis.

Question 3: Research has shown that there is a need for a higher quality guitar on the market.    Sound Eleven would be able to produce a higher quality guitar, called the “Turn it Up” on their existing equipment if they upgraded the wood and strings at an additional cost of $25 per guitar. However, they would need a new paint booth to be able to produce the better paint job required for the “Turn it Up” guitar. This would increase fixed overhead costs by $60,000 per month (still based on normal production volume of 5,000 units). Maximum production for both types of guitars together would still be 6,000 units because the majority of the same equipment would be used. The “Turn it Up” guitars would sell for $450 each. A) What would be the break-even point if String Thing only sold “Turn it Up” guitars? B) Create a contribution income statement for a month in which String Thing sold 3,500 “High Volume” guitars, and 2,000 “Turn it Up” guitars. C) Explain, in your own words, the difference between fixed and variable costs and how they impact profitability.

Explanation / Answer

1. Break even sales = Total Fixed expenses / (Weighted average selling price-Weighted Avergae variable cost)

In units:

Marketing costs per unit                                                                         45

Total variable costs = 95+45 = 140

Break even sales =450000/(350-150) = 2143 units

In sales $ = 2143*350 = 750,000

2. If the company accepts the order @$300 per unit, it can still sell 3,000 units @350

Yes, sound eleven should accept this order

3.

Fixed expenses are incurred irrespective of whether production / sales are made or not. Hence they are uncontrollable expenses. Variable costs are incurrent only when production / sales are made, hence they are controllable. If an entity wants to increase their profitabilitym they should work towards reducing the variable expenses.

                       980 units

Fixed expense per unit 50+40= 90 Total (5,000*90) 450000 Selling price per unit 350 Variable costs per unit Materials 30 Labor 40 Overheads 25 Total Variable costs 95

Marketing costs per unit                                                                         45

Total variable costs = 95+45 = 140

Break even sales =450000/(350-150) = 2143 units

In sales $ = 2143*350 = 750,000

2. If the company accepts the order @$300 per unit, it can still sell 3,000 units @350

Sales (3,000*300 + 3,000*250)               1,950,000 Direct expenses Materials                180,000 Labor                240,000 Overheads - Variable                  75,000 Overheads - Fixed                250,000 Total Cost of goods sold                   745,000 Gross Profit               1,205,000 Marketing costs Variable (6,000*45)                270,000 Fixed (5,000*40)                200,000 Total Marketing costs                   470,000 Net Profit                   735,000

Yes, sound eleven should accept this order

3.

Break even sales Fixed costs Existing                450,000 Additional                  60,000 Total                510,000 Selling price 450 Variable costs (140+25) 165 Contribution margin per unit 285 Break even sales (510,000/285)                  1,789 units Contribution Income Statement Particulars Total Sales                     2,125,000 Variable maufacturing costs Materials                         165,000 Labor                         220,000 Overheads - Variable                         137,500 Additional costs                           50,000 Total Variable maufacturing costs                         572,500 Variable selling costs                         247,500 Contribution Margin                     1,305,000 Fixed expenses: Fixed overheads                         310,000 Fixed Marketin costs                         225,000 Net Profit                         770,000

Fixed expenses are incurred irrespective of whether production / sales are made or not. Hence they are uncontrollable expenses. Variable costs are incurrent only when production / sales are made, hence they are controllable. If an entity wants to increase their profitabilitym they should work towards reducing the variable expenses.

                       980 units

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