Case Study: Bill French
Bill has assumed that Duo-Products' relevant range for fixed costs will remain constant even after planned expansion of production capacity. He has also assumed that there is just one breakeven point for the firm (by taking the average of the 3 products). He has also assumed that the sales mix will remain constant. Two other assumptions are that total revenue and total expenses behave in a linear manner over the relevant range. These 2 are standard when Cost Volume Profit analysis is carried out.
a) There is an extra $720,000 a year in fixed costs estimated by Fred Williams for this year. Since capacity is being expanded to increase production of Product C, it could be assumed that this increase should be allocated to this product. Production of Product A is to be scaled down, but as there isn't any information as to whether its relevant range of fixed costs will change, I have left its level of fixed costs unchanged. As a result both A's and B's breakeven points remain the same. For C the breakeven point is 354,545 units. The overall breakeven point is 1,035,686 units. b) Duo-Products must make a $1.2 million profit before tax to meet this requirement. To do this it must sell 1,372,494 units. c) An increase in variable costs across the board by 10% would increase the average variable cost to $3.72 per unit. For Duo-Products to break even under these conditions it would need to sell 1,144,440 units. d) Duo-Products would have to sell 1,516,615 units to meet both the extra dividends and expected union requirements.
Breakeven analysis would suggest that a substantial percentage of Product A's profits go to pay for variable costs instead of fixed costs. Both Products B and C have better ratios in this regard, with C's being the highest. If the planned increase in C's production goes ahead it will take up almost 50% of the company's production capacity. The company's total utilisation of capacity will be 87.50%, so there is...
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