6-4. Nonlinear Cost Structure and Breakeven Analysis Frank Alexander was Preside

Question

6-4. Nonlinear Cost Structure and Breakeven Analysis Frank Alexander was President of the Mason Company, a small producer of valves in a highly competitive marke him great cost. Standard capaci level ( t. A recent drop in the price of the valves has caused oncern. since the price was now below the Mason Company's standard cost was determined from operating at 80 percent of the maximum ty of 10.000 valves per month. Alexander did not normally operate above this of 8.000 valves per month) since the higher production required overtime work t c that significantly increased variable costs. The fixed costs of the Mason Company were $40.000 per month and variable costs were S15 per valve for production levels up to 8,000 valves per month. Con- sequently the standard cost of the valve was set at a $20, based on operating at the desired level of 80 percent of capacity. Normally the price of the valve ranged from 21 to S23 allowing a small but adequate return on the Mason Company's modest investment in machinery and facilities. For production above the standard volume, unit variable costs for the a tional units increased by: s percent above the normal variable cost for volume between 30 and 33 percent of capacity: 20 percent above the normal variable cost for volume between 85 and 90 percent of capacity: 30 percent above the normal variable cost for volume between 90 and 100 percent of capacity. Recently, the price of the valves had dropped about 10 percent to $19 per valve. Mr. Alexander felt he was now in a no-win situation since he was losing n every valve he was selling. While he saw some opportunities for increasing his sales volume above the current level of 8.000 units per month. he felt this would only make matters worse. since he felt he was losing money at current volumes and the variable costs on the additional units produced would be even higher. Required: . Comment on Frank Alexander's analysis of the price-cost squeeze in which he now finds himself. At what point would you recommend that he actually turn down orders at 519 per valve. Assuming the price returns to its previous level of S21. at what volumes would the Mason Company operate profitably? 2.

Explanation / Answer

In respect of the Problem which you have put to answer we wish to submit the undrmentioned one:

1.In respect of operation at Price of 19$ Frank alexander feeling of no win situation is be correct .This correctness we can substantiate with the working that we have done for Checking the claim & found that it will be in loss at all the four level that they have option to operate but along with that we have found one interesting note that he will be minimum losses if he operate at the 85 to 90% capacity level when we compare the losses with the other levels.for your understanding we are belowmentioning the working :

But if he operates at 85 to 90% capacity Level he will incurred the minimum losses comparing with the other level

2 In case the Price will assumed to move 21$ In that case they will be maximum profitable position at the level 90 to 100% which we can substantiate through the below mentioned workings:

STATEMENT SHOWING THE DETAILS OF COST & SALES CAPACITY 80% 85% 90% 100% PRODUCTION UNITS 8000 8500 9000 10000 FIXED COST $40,000 $40,000 $40,000 $40,000 VARIABLE COST FOR FIRST 8000 UNITS $1,20,000 $1,20,000 $1,20,000 $1,20,000 For NEXT 500 UNITS 0 $8,625.00 $8,625.00 $8,625.00 For NEXT 500 UNITS 0 0 $9,000.00 $9,000.00 For NEXT 1000 UNITS 0 0 0 $19,500.00 TOTAL VARIABLE COST $1,20,000 $1,28,625 $1,37,625 $1,57,125 TOTAL COST $1,60,000 $1,68,625 $1,77,625 $1,97,125 SELLING PRICE $1,52,000 $1,61,500 $1,71,000 $1,90,000 PROFIT/(LOSS) -$8,000 -$7,125 -$6,625 -$7,125 Frank alexander analysis in respect of price Squeeze is be correct as if operate with existing price in the market , it will incurred the loss on all the capacity level

But if he operates at 85 to 90% capacity Level he will incurred the minimum losses comparing with the other level

2 In case the Price will assumed to move 21$ In that case they will be maximum profitable position at the level 90 to 100% which we can substantiate through the below mentioned workings:

STATEMENT SHOWING THE DETAILS OF PROFIT AT PRICE OF 21$ CAPACITY 80% 85% 90% 100% PRODUCTION UNITS 8000 8500 9000 10000 FIXED COST $40,000 $40,000 $40,000 $40,000 VARIABLE COST FOR FIRST 8000 UNITS $1,20,000 $1,20,000 $1,20,000 $1,20,000 For NEXT 500 UNITS 0 $8,625.00 $8,625.00 $8,625.00 For NEXT 500 UNITS 0 0 $9,000.00 $9,000.00 For NEXT 1000 UNITS 0 0 0 $19,500.00 TOTAL VARIABLE COST $1,20,000 $1,28,625 $1,37,625 $1,57,125 TOTAL COST $1,60,000 $1,68,625 $1,77,625 $1,97,125 SELLING PRICE $1,68,000 $1,78,500 $1,89,000 $2,10,000 PROFIT/(LOSS) $8,000 $9,875 $11,375 $12,875 Assuming that Prices will return to the 21$. In that Case it will be beneficial to operate at 90 to 100% capacity Level comparing with other capacity levels

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