Cost Analysis Activity
Instructions:-
In an Excel or Word file, provide the information specified in the prompts below.
NOTE: The four scenarios represent four independent companies, and should be calculated and represented separately in your response.
ASSIGNMENT PROMPTS
Xstrata incurs variable costs of $24 per unit for a product that has a selling price of $36. If the breakeven point is $84,000 of annual sales, what are the company’s annual fixed costs?
Yallop Ltd has annual fixed costs of $76,000. The variable costs are $5 per unit and the breakeven point is 8000 units. What is the selling point per unit?
Wendy Ltd wishes to attain a before-tax net profit equal to 20% of sales revenue. Variable costs are 60% of sales and fixed costs are $360,000. Calculate the dollar amount of sales necessary for achieving the profit goal.
Zulu Ltd has a product that sells for $73 and is produced at a variable cost of $59/unit. The variable costs can be reduced by 25% by installing a new piece of equipment. Installing the new equipment will increase fixed costs from the present level of $120,000 to $170,000. Calculate the present break-even point and the new break-even point if the equipment is installed.
Solution
Cost Analysis Activity
Xstrata incurs variable costs of $24 per unit for a product that has a selling price of $36. If the breakeven point is $84,000 of annual sales, what are the company’s annual fixed costs?
The annual fixed costs can be computed through a reverse analysis of the breakeven point. The breakeven point represents that sales point at which the revenue gained exactly matches the total cost of production (Cafferky, 2010). The breakeven point is usually calculated using the formula below, which represents the relationship between fixed costs, variable costs and selling price.
BP= F/((P-v))
Whereby;
BP = the breakeven point in terms of the number of units sold
F = Total fixed production costs
v = Variable cost per unit
P = Selling price per unit
Here, the variable required is the total fixed costs, which can be computed by making it the subject in the formula as below:
F= BP(P-v)
The number of units required to breakeven can be determined by dividing the breakeven sales amount ($84,000) by the selling price per unit ($36). Thus, the fixed costs would be calculated as below:
F= 84000/36(36-24)
84000/36*12
= $28,000
The annual fixed costs for Xstrata are $28000
Yallop Ltd has annual fixed costs of $76,000. The variable costs are $5 per unit and the breakeven point is 8000 units. What is the selling point per unit?
A similar approach involving reverse breakeven analysis can be used to calculate the selling point per unit. Using the same formula as above, the fo9cus would now be on making the selling point the subject.
BP= F/((P-v))
From the above, the selling point would be calculated as:
P= F/BP+v
P= 76000/8000+5
= $14.5
Thus, the selling point per unit is $14.5
Wendy Ltd wishes to attain a before-tax net profit equal to 20% of sales revenue. Variable costs are 60% of sales and fixed costs are $360,000. Calculate the dollar amount of sales necessary for achieving the profit goal.
In order to achieve the profit goal, Wendy would be seeking to make sales that are 20% above the total cost of production. The above computation requires the use of the alternative breakeven formula, which involves a contribution margin, whereby the contribution margin refers to the amount remaining after variable costs have been deducted (Warren, Reeve & Duchac, 2016). In the case of Wendy’s since the variable costs are 60% of the sales revenue, then the remainder is 40%, which is consequently the contribution margin ratio. The applicable breakeven formula in this case would be:
SR= (F+Op)/CMR
The general formula from which the above formula is derived is:
SR= F/CMR
Whereby;
SR = Required Sales Revenue in dollars
F = Total fixed production costs
CMR = Contribution Margin Ratio
At the breakeven point, Sales revenue is equivalent to breakeven sales hence the use of BP. This formula can be used to determine the sales revenue required to achieve a particular rate of profitability, by adding operating profit to the fixed costs. This formula then becomes
SR= (F+Op)/CMR
Whereby;
SR = Required Sales Revenue in dollars
F = Total fixed production costs
CMR = Contribution Margin Ratio
Op = Operating Profit
In the current case, the operating profit is expressed as a percentage. The required sales would thus be calculated as follows:
SR= (F+0.2SR)/CMR
SR= (360000+0.2SR)/0.4
0.4SR= 360000+0.2SR
0.4SR-0.2SR= 360000
= $1,800,000
Hence, the required sales volume to achieve a 20% operating
profit is $1,800,000.
Zulu Ltd has a product that sells for $73 and is produced at a variable cost of $59/unit. The variable costs can be reduced by 25% by installing a new piece of equipment. Installing the new equipment will increase fixed costs from the present level of $120,000 to $170,000. Calculate the present break-even point and the new break-even point if the equipment is installed.
This situation involves two different scenarios. For the first scenario, the variable cost is $59/unit while the fixed costs are $120,000. The breakeven point can be calculated using the first formula as below:
BP= F/((P-v))
BP= 120000/((73-59)) = 120000/14
The breakeven point is 8,572 units or $625,756 sales dollars.
In the second scenario, the variable costs would be reduced by 25%, yielding a variable cost of $44.25. The fixed costs would now be $170,000. The breakeven point would then be:
BP= F/((P-v))
BP = 170,000/((73-44.25)) = 120000/14
The breakeven point would now be 5914 units, or $431,722
dollars.
References
Cafferky, M. (2010). Breakeven Analysis: The definitive guide to cost-volume-profit analysis. New York: Business Expert Press.
Warren, C. S., Reeve, J. M., & Duchac, J. (2013). Financial & managerial accounting. Boston, MA: Cengage Learning.