PROBLEM 3-25 Changes in Fixed and Variable Expenses; Break-Even and Target Profi

Question

PROBLEM 3-25 Changes in Fixed and Variable Expenses; Break-Even and Target Profit Analysis LO3-4, LO3-5, LO3-6] Neptune Company produces toys and other items for use in beach and resort areas. A small, inflat- able toy has come onto the market that the company is anxious to produce and sell. The new toy will sell for $3 per unit. Enough capacity exists in the company's plant to produce 16,000 units of the toy each month. Variable expenses to manufacture and sell one unit would be $1.25, and fixed expenses associated with the toy would total $35,000 per month. The company's Marketing Department predicts that demand for the new toy will exceed the 16,000 units that the company is able to produce. Additional manufacturing space can be rented from another company at a fixed expense of S1,000 per month. Variable expenses in the rented facility would total $1.40 per unit, due to somewhat less efficient operations than in the main plant.

Explanation / Answer

Neptune Company

Break-even point in units –

Break-even point in units = fixed cost/contribution margin per unit
contribution margin per unit = unit sales price – unit variable cost

Unit sales price = $3

Unit variable cost = $1.25

Contribution margin per unit = $1.75

Fixed expenses = $35,000

Break-even point in units = $35,000/1.75 = 20,000 units

Break-even point in dollar sales:

Break-even point in dollar sales = fixed cost/contribution margin ratio

Contribution margin ratio = contribution/sales price

= $1.75/$3 = 58.33%

Break-even point in dollar sales = $35,000/58.33% = $60,000

Desired unit sales = (fixed cost + target profit)/contribution margin per unit

Fixed cost = 35,000

Target profit = $12,000

CM per unit = $1.75

Desired unit sales = (35,000 + 12,000)/1.75 = 26,857 units

When the company rents space –

Unit Variable cost = $1.40

Contribution margin = $3 - $1.40 = $1.60

CM ratio = 1.60/3 = 53.33%

Fixed cost = $35,000 + $1,000 = $36,000

BEP – unit sales = 36,000/1.60 = 22,500

BEP – dollar sales = 36,000/53.33% = $67,500

Desired unit sales = (fixed cost + target profit)/contribution margin per unit

Fixed cost = 36,000

Target profit = $12,000

CM per unit = $1.60

Desired unit sales = (36,000 + 12,000)/1.60 = 30,000 units

Return on profit = 25% of $36,000 = $9,000

Contribution margin on units sold above BEP = CM at BEP – manager’s commission

= $1.60 - $0.10 = $1.50

Number of units = (36,000 + 9,000)/1.5 = 30,000 units

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