Scholes Systems supplies a particular type of office chair to large retailers su

Question

Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 95,000 units for $55 per unit. The variable production costs are $25, and fixed costs amount to $1,550,000. Production engineers have advised management that they expect unit labor costs to rise by 15 percent and unit materials costs to rise by 10 percent in the coming year. Of the $25 variable costs, 40 percent are from labor and 30 percent are from materials. Variable overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 7 percent as a result of increased taxes and other miscellaneous fixed charges. The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 10 percent during the year. Required: (a) Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented (b) Compute the volume of sales and the dollar sales level necessary to provide the 10 percent increase in profits, assuming that the maximum price increase is implemented.(c) If the volume of sales were to remain at 95,000 units, what price change would be required to attain the 10 percent increase in profits? Calculate the new price

Explanation / Answer

Present Scenario

Sale Price = $55 Variable Cost = $25 Contribution = $30 Units sold = 95000 units Total Contribution = $2850000 Total Fixed Cost = $1550000 Profit = $1300000   

After Inflation

Material Cost (25 x 30%) x 1.10 = $8.25 Labor Cost (25 x 40%) x 1.15 = $11.50 Variable O/H (25 x 40%) x 1.20 = $12.00 Total Variable Cost = $31.75 Selling Price (55 x 1.1) = $60.50 Contribution/Unit =$28.75 Fixed Cost ($1550000 x 1.07) =$1658500

(a) Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented

Desired Contribution = (1658500 + 1300000) = $2958500

Desired Sales = ($2958500 / $28.75) = 102905 Units or (102905 x 60.50) i.e. $6225752.5

(b) Compute the volume of sales and the dollar sales level necessary to provide the 10 percent increase in profits, assuming that the maximum price increase is implemented.

Desired Contribution = (1300000 x 1.1) + 1658500 = $3088500

Desired Sales = (3088500 / 28.75) = 107427 Units or (107427 x 60.50) = $6499333.5

(c) If the volume of sales were to remain at 95,000 units, what price change would be required to attain the 10 percent increase in profits

Sales = 95000 units

Variable Cost = $31.75

Desired Contribution = (1300000 x 1.1) + 1658500 = $3088500

Desired Sales = Desired Contribution / (Sales Price/unit - Variable Cost/unit) 95000 units = 3088500 / (x - 31.75) x = $64.26 per unit

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