Question

Fredonia Inc. had a bad year in 2013. For the first time in its history, it operated at a loss. The company’s income statement showed the following results from selling 80,000 units of product: Net sales $2,000,000; total costs and expenses $1,740,000; and net loss $135,000. Costs and expenses consisted of the following.

	Total	Variable	Fixed
Cost of goods sold	$1,468,000	$950,000	$518,000
Selling expenses	517,000	92,000	425,000
Administrative expenses	150,000	58,000	92,000
	$2,135,000	$1,100,000	$1,035,000

Management is considering the following independent alternatives for 2014.

1. Increase unit selling price 25% with no change in costs and expenses.

2. Change the compensation of salespersons from fixed annual salaries totaling $200,000 to total salaries of $40,000 plus a 5% commission on net sales.

3. Purchase new high-tech factory machinery that will change the proportion between variable and fixed cost of goods sold to 50:50.

Instructions

(a) Calculate the break even point for 2014.

(b) Compute the break even point in dollars under each of the alternative courses of action. (Round to the nearest dollar:) Which course of action do you recommend?

Answer 1

a) Breakeven = fixed cost / pv ratio

Fixed cost = 1035000

Pv ratio = Contribution / sales * 100

= ( 2000000 - 1100000) /2000000* 100 = 45%

Break even = 900000/45% = 2000000

b)

Case 1

New sales = 2000000 + 25% = 2500000

New pv ratio = (2500000 - 1100000) /2500000* 100 = 56%

Breakeven = 1035000/56% = 1848214.29

2 case

new inventory fixed cost = 1035000 + 40000 = 1075000

New contribution = 2000000 - 1100000 - (2000000*5%) = 800000

New pv ratio = 800000 / 2000000* 0.4 = 0.16

Breakeven = 1075000 / 16% = 6718750

3 case

• Fixed cost = 1100000 + 1035000 / 2 =  1617500
• Variable cost = 1617500
• pv ratio = 50%

Breakeven = Fixed cost / pv ratio = 1617500 / 50% = 3235000

2