Question

Martha Manufacturing produces a single product that sells for $80. Variable costs per unit equal $32. The company expects total fixed costs to be $72,000 for the next month at the projected sales level of 2,000 units. In an attempt to improve performance, management is considering a number of alternative actions. Each situation is to be evaluated separately.

1) What is the current breakeven point in terms of number of units?
2) Suppose management believes that a $16,000 increase in monthly advertising expense will result in a considerable increase in sale. Sale must increase by how much to justify this additional expenditure?
3) Suppose that management believes that a 10% reduction in the selling price will result in a 10% increase in sales. If this proposed reduction in selling price is implemented,
a) Operating income will decrease by $8,ooo
b) Operating income will increase by $8,000
c) Operating income will decrease by $16,000
d) Operating income will increase by $16,000.

Answer 1

The current break-even point for Martha Manufacturing is 1,500 units. To justify an additional $16,000 in advertising expenses, the company needs to sell an additional 334 units. If the selling price is reduced by 10% and sales volume increases by 10%, the operating income will increase by $8,000.

Step-by-step explanation:

Martha Manufacturing Break-even Analysis

To determine the break-even point in terms of number of units, we use the formula:

Break-even Point (Units) = Fixed Costs / (Selling Price per Unit - Variable Cost per Unit)

Using the provided numbers:
Break-even Point (Units) = $72,000 / ($80 - $32) = $72,000 / $48 = 1,500 units

Sales Increase Justification for Additional Advertising Expenses:

For the $16,000 increase in advertising expense to be justified, the increase in contribution margin must offset this cost. The contribution margin per unit is currently $48 ($80 selling price - $32 variable cost).

Required Sales Increase = Additional Advertising Expense / Contribution Margin
Required Sales Increase = $16,000 / $48 ≈ 334 units

Analysis of a 10% Reduction in Selling Price and Resulting 10% Increase in Sales Volume:

New selling price: $80 - 10% of $80 = $80 - $8 = $72
Increase in sales volume: 10% of 2,000 units = 200 units

New Operating Income:
Additional Revenue = 200 units * $72 = $14,400
Additional Variable Cost = 200 units * $32 = $6,400
Change in Operating Income = Additional Revenue - Additional Variable Cost = $14,400 - $6,400 = $8,000

Therefore, the correct answer is (b) Operating income will increase by $8,000.

Answer 2

Each unit sells: $80
Each unit costs to make: $32
Fixed costs: 72,000
Goal: 2,000 units sold

If they meet their goal, let's see how that would go:

(2,000 * 80) - (2,000 * 32) - 72,000 = ?
160,000 - 64,000 - 72,000 = 24,000

24,000 is the profit they would make for hitting their goal.

Question 1:
What is the break-even point? The break-even means they make no money, but they also lose no money. So that final number (24,000) would be 0 instead. How many units would they have to make to hit zero?
(x * 80) - (x * 32) - 72,000 = 0.
80x - 32x = 72,000
48x = 72,000
x = 1500 units

We can verify by using our first formula we've already determined, using this new value for units.
(1,500* 80) - (1,500 * 32) - 72,000 = ?
120,000 - 48,000 - 72,000 = 0? True!

Question 2: If they increase their expenses by 16,000, what is their new break even point?

(x * 80) - (x * 32) - 72,000 - 16000 = 0.
80x - 32x - 88000 = 0
48x = 88000
x = 1833

Question 3: 10% reduction in selling price and 10% increase in sales. (Assuming based off the original formula the problem provided.)

Original: (2,000 * 80) - (2,000 * 32) - 72,000 = ?

10% Reduction in price: 8
80-8 = 72

10% increase in sales: 200
2000 + 200 = 2200

Plugin to our formula:
(2200 * 72) - (2200 * 32) - 72,000 = ?
158400 - 70400 - 72,000 = 16,000

Since this number is positive, this is income. (D)