Question

Disk City, Inc. is a retailer for digital video disks. The projected net income for the current year is $2,700,000 based on a sales volume of 270,000 video disks. Disk City has been selling the disks for $16 each. The variable costs consist of the $2 unit purchase price of the disks and a handling cost of $2 per disk. Disk City’s annual fixed costs are $540,000. Management is planning for the coming year, when it expects that the unit purchase price of the video disks will increase 30 percent. (Ignore income taxes.)

What volume of sales (in dollars) must Disk City achieve in the coming year to maintain the same net income as projected for the current year if the unit selling price remains at $16?

Answer 1

Selling price per unit = $16

unit purchase price of the video disks will increase 30 percent.

unit purchase price = 2 + 2 x 30%

= 2 + 0.60

= $2.60

Variable cost per unit = Purchase price + Handling cost

= 2.60 + 2

= $4.60

Unit Contribution margin = Unit Selling price –Unit Variable cost

= 16 - 4.60

= $11.40

Contribution margin ratio = Contribution margin per unit/Selling price per unit

= 11.40/16

= 71.25%

Target profit = $2,700,000

Dollar sales to get a target profit = (Fixed cost + Target profit)/Contribution margin ratio

= (540,000 + 2,700,000)/71.25%

= 3,240,000/71.25%

= $4,547,369

Hence, Disk City must achieve sales of $4,547,369 in the coming year