3. (One step beyond) PC Fun & Games, Inc., produces a game for personal computer

Question

3. (One step beyond) PC Fun & Games, Inc., produces a game for personal computers on a CD-ROM disk, which is entitled: Armageddon, the Final Battle. The company sells the disk to software retailers for $20.00, each, with a 5% discount for orders of 100 copies or more; virtually every retailer takes the discount. The variable costs of producing the disks are low, totaling only $7.00 each for the blank disk onto which the game is copied, the wages of the machine operator, and the packaging. The game has become a best seller, and the production manager must plan to expand the capacity of the plant to turn out CD-ROM disks. CD-ROM disks are produced on a machine which makes copies of a master disk, one at a time. Each copy takes fifteen minutes, which includes inserting the blank disk, imprinting the game, and removing the finished disk. At present, the Company has four machines; each machine cost $80,000 and has a service life of five years. The Company operates two eight-hour shifts per day, 50 weeks per year, and the machines require servicing and adjustments for one hour every day. New machines can be purchased for $85,000. They also have a service life of five years and require one hour of servicing, but they can make copies in ten minutes. Because of the savings in copying time, the variable cost will drop to $6.00 per disk. a. What is the annual depreciation expense of one present machine? (Use straight line depreciation expense = cost/service life.) (5 pts) b. What is the present breakeven point? (5 pts)

Explanation / Answer

a. Annual depreciation expense of one present machine = $ 80,000 / 5 = $ 16,000

(As required in the question, straight line method of depreciation has been used wherein annual depreciation = Cost of asset / Service life. Cost of each existing machine = $80,000 with a service life of 5 years)

b. Break-even point refers to the quantum of sales volume whereby the company is in a no profit, no loss situation or whereby the fixed cost exactly equal the total contribution at the level of break-even sales volume.

i.e., Fixed Cost = Break-even sales volume * Contribution

Fixed cost =Break-even sales volume * (Revenue per unit - Variable costs per unit)

Break-even sales volume = Fixed cost / (Revenue per unit- Variable costs per unit) ...(a)

The company sells the disks at $20 each with a bulk discount of 5% on orders above 100 units which every dealer avails.

Thus effective revenue per unit for the company = $20 (1 - 5%)

= $ 19

Variable cost per unit = $ 7

Fixed cost of the company per annum = Annual depreciation cost of 4 machines = $ 16,000 * 4 = $ 64,000

Thus, putting values in (a)

Break-even quantity = $ 64,000 / ($19 - $7) = 5,333 units

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