Cost Structures for Global Shippers Inc.
Management from Global Shippers Inc, an international shipping business, is in the process of assessing the choice between two different cost structures for the business. Option A has relatively higher variable costs per unit shipped but lower annual fixed costs, while Option B has the opposite—relatively lower variable costs in its cost structure but higher fixed costs. Assume that delivery selling prices per unit are constant. The table below contains critical information in making the decision:
Cost Information |
Option A |
Option B |
Delivery price (revenue) per shipment |
$100 |
$100 |
Variable cost per shipment delivered |
$85 |
$60 |
Contribution Margin per unit |
$15 |
$40 |
Fixed costs (annual) |
$1,200,000 |
$4,500,000 |
Management wants you to write a professional report, answering the following questions:
Questions
SOLUTION:
Option A ($) | Option B ($) | |
Delivery Price per shipment | 100 | 100 |
Less: Variable Cost per shipment | 85 | 60 |
Contribution per shipment | 15 | 40 |
Fixed Cost (Annual) | 1,200,000 | 4,500,000 |
BREAKEVEN POINT IN TERMS OF VOLUME (NO. OF SHIPMENTS PER YEAR):
For Option A:
Breakeven Point = Fixed cost / contribution per shipment
= 1,200,000 / 15
= 80,000 shipments per year
For Option B:
Breakeven Point = Fixed cost / contribution per shipment
= 4,500,000 / 40
= 112,500 shipments per year
TO PRODUCE OPERATING INCOME OF $30,000 UNDER OPTION A, NO. OF SHIPMENTS TO MAKE:
Under option A:
Desired Profit = $ 30,000
Breakeven sales = fixed cost + desired profit / contribution per shipment
= 1,200,000 + 30,000 / 15
= 1,230,000 / 15
= 82,000 shipments per year
Hence 82,000 shipments has to be made to produce operating income of $ 30,000.
TO PRODUCE OPERATING MARGIN EQUAL TO 9% OF SALES REVENUE UNDER OPTION A, NO. OF SHIPMENTS TO MAKE:
Operating Profit = 9% of sales revenue
= 9% *100
= 9 per shipment
assume shipments to be made = x
x = 1,200,000 + 9x / 15
15x = 1,200,000 + 9x
15x - 9x = 1,200,000
6x = 1,200,000
x = 1,200,000 / 6
x = 200,000 shipemts per year
Hence 200,000 shipments has to be made to produce operating margin equal to 9% of sales revenue
How many shipments are required under Option B to produce net income of $180,000 per year, given a corporate tax rate of 40%?
It is assume that tax effect has been given to arrive the net income of $ 180,000
Breakeven sales = fixed cost + desired profit / contribution per shipment
= 4,500,000 + 180,000 / 40
= 4,680,000 / 40
= 117,000 shipments per year
Hence 117,000 shipments has to be made to produce net income of 180,000
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