PROBLEM 4-3. High-Low, Break-Even [LO 1, 2 Lancer Audio produces a high-end DVD
ID: 412997 • Letter: P
Question
PROBLEM 4-3. High-Low, Break-Even [LO 1, 2 Lancer Audio produces a high-end DVD player that sells for $1,300. Total operating expenses for the past 12 months are as follows: Units Produced and Sold Cost August September October November December January February March April May June July 165 130 150 145 155 170 140 150 145 150 140 135 $140,345 116,990 130,650 127,670 133,790 143,910 123,520 130,950 127,385 129,865 122,720 120,255 REQUIRED a. Use the high-low method to estimate fixed and variable costs. b. Based on these estimates, calculate the break-even level of sales in units. (Round to the nearest whole unit.) c. Calculate the margin of safety for the coming August assuming estimated sales of 175 units. d. Estimate total profit assuming production and sales of 175 units. e. Comment on the limitations of the high-low method in estimating costs for Lancer Audio.Explanation / Answer
a. Variable cost per unit = (y2-y1)/(x2-x1) where y2 = total cost at highest level of activity, y1 = total cost at lowest level of activity, x2 = number of units at highest level of activity and x1 = number of units at lowest level of activity
We can see that highest level of activity is in January at 170 units and lowest level is at 130 units in September.
Thus variable cost = (143910-116990)/(170-130) = $673
Fixed cost = total cost at highest activity - (673*units at highest activity) = 143910 - (673*170) = $29,500
b. Break even = fixed cost/(selling price-variable cost) = 29,500/(1300-673) = 47.05 units or 47 units (rounded off)
c. expected sales = 175*$1300 = $227,500. Break even sales = 47*1300 = 61,100
Thus margin of safety = 227500-61100 = $166,400
margin of safety ratio = 166400/227500 = 73.14%
d. sale revenue = 175*1300 = 227,500. Variable costs = 175 units*$673 = $117,775. Fixed costs = 29,500.
Thus profit = revenue-fixed costs-variable costs = 227,500-29,500-117,775 = $80,225
e. The major problem, with the high-low method, is that it assumes that costs are linearly distributed. In other words, costs are assumed to behave in a predictable manner.
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