Noble Enterprises Ltd produces and sells one product. The forecasts for the next

Question

Noble Enterprises Ltd produces and sells one product. The forecasts for the next period were as follows: Maximum capacity 200,000 units; Forecast output 75% of capacity; Selling price Rs20; Variable costs Rs10; Total fixed costs Rs.750, 000.

Two proposals have been put forward to the company for using the spare capacity:

• If the selling price is reduced by 10%, it would lead to a 20% increase in demand for the product.

• An overseas developing company is interested in purchasing the remaining 25% of capacity if the selling price per unit could be brought down to Rs.14 per unit.

(a)    For each of the proposals put forward to the company, calculate the expected total profit, assuming that there are no changes in the cost structure.

(b)    Advise the management which of the proposals, if any, should be accepted

Explanation / Answer

Present profit at 75% capacity i.e 150000 units

Contribution=selling price- variable cost

=$20-$10=$10

Total contribution=$1500000

Less: fixed exp=$750000

Profit=$750000

Proposal1

SP reduce by 10% , demand increase by 20%

Total demand =180000 Selling price=$18

Contribution=Selling price- variable cost=$18-$10=$8

Total contribution=$8*18000=$1440000

Less: fixed cost=$750000

Expected profit=$690000

Proposal 2

Contribution for 75% capacity= $10

Contribution for 25% capacity= $4

Total contribution=$1500000+$200000

=$1700000

Less: fixed exp=$750000

Expected profit=$950000

B) proposal2 of overseas company should be accepted as it leads to increase in profit of the company by $200000 and costs remain the same. Proposal1 is not beneficial as it has reduced the present profit to $690000 from $750000

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