Question

Gina owns G’s Clay Pots, a manufacturer of clay planting pots of all different sizes.

Gina is considering manufacturing a new product line: ceramic pots. He collects the following estimates for each ceramic pot:

Sales price per pot = $28

Direct materials cost per pot = $5

Direct labor cost per pot = $3

Variable utilities costs per pot = $2

In addition to the costs above, Gina must develop a new production line for the ceramic pots. She can rent additional machinery for $20,000 per month. The additional machinery can produce 2,000 pots per month, but the machinery rent cost is the same no matter how much of the capacity is actually used.

Finally, the ceramic pots require $10,000 in additional fixed operating costs per month

Gina’s Analysis and Interpretation

Gina has many years of industry experience, as well as an MBA degree. She recalls learning cost-volume-profit analysis in her accounting courses, and uses this analysis to compute the break-even point for the ceramic pot line.

Her analysis is as follows:

Breakeven Point =

Total Fixed Costs/Contribution Margin per Unit

Total Fixed Costs = $10,000

Contribution Margin per unit = Selling price per unit – Variable costs per unit

Selling price = $28

Variable costs:

$5 in direct materials

$3 in direct labor

$2 in utilities

$10 in machinery rent ($20,000 per month / 2,000 pots per month)

Breakeven Point = $10,000 / ($28 – 5 – 3 – 2 – 10) = $10,000 / $8 = 1,250 pots

Gina compares her break-even point to her facility’s capacity and to her estimates of monthly demand.

• She notes that she has sufficient capacity to produce enough pots to break-even, as her facility can produce up to 2,000 ceramic pots per month.
• Gina estimates average monthly demand to be 1,700 units.

Gina feels that her plan to produce and sell ceramic pots is feasible and will be profitable.

Given this finding, she runs an analysis regarding the feasibility of earning $3,000 in net income (after income taxes of 30%).

She finds that she needs 1,625 units to achieve the desired net income, and concludes that monthly capacity and demand are sufficient.

QUESTION #1

Was the analysis completed correctly, or are there errors in the calculations?

If the analysis is inaccurate, identify the errors and explain why they are errors.

If applicable, provide a “corrected” analysis.

QUESTION #2

Explain to the client how the results of the analysis should be interpreted.

Is the client’s original conclusion correct? Should it be adjusted or qualified in some manner?

Answer 1