3. Break-even analysis Aa Aa To be profitable, a firm has recover its costs. The

Question

3. Break-even analysis Aa Aa To be profitable, a firm has recover its costs. These costs include both its fixed and its variable costs. One way that a firm evaluates at what stage it would recover the invested costs is to calculate how many units or how much in dollar sales is necessary for the firm to earn a profit. Consider the case of Free Spirit Industries Inc.: Free Spirit Industries Inc. is considering a project that will have fixed costs of $12,000,000. The product will be sold for $41.50 per unit, and will incur a variable cost of $12.80 per unit. Given Free Spirit's cost structure, it will have to sell units to break even on this project (QBE) Free Spirit Industries Inc.'s marketing sales director doesn't think that the market for the firm's goods is big enough to sell enough units to make the company's target operating profit of $25,000,000. In fact, she believes that the firm will be able to sell only about 150,000 units. However, she also thinks the demand for Free Spirit Industries Inc.'s product is relatively inelastic, so the firm can increase the sale price. Assuming that the firm can sell 150,000 units, what price must it set to meet the CFO's EBIT goal of $25,000,000? O $298.39 $272.44 O $259.47 $324.34

Explanation / Answer

Free Sprit Industry Inc. has considering a project which will have

fixed cost = $1,20,00,000

selling price per unit =$41.50 per unit

Variable cost =$12.80 per unit

Break even Quantity of Free Sprit Industry Inc. is :

Break Even Quantity = fixed cost/ contribution per unit

contribution per unit = selling price per unit - variable cost per unit

contribution per unit = $41.50 - $12.80 = $28.70 per unit

Break Even Quantity = $1,20,00,000/ $ 28.70 = 4,18,118 units

Unit Sales = (Fixed Costs + Target Profit )/Contribution Margin per Unit

assume that selling price per unit =x

Contribution Margin per Unit = x- $12.80

1,50,000=($1,20,00,000 + $ 2,50,00,000 )/ x-$12.80

1,50,000x- $19,20,000=$3,70,00,000

x=$ 3,89,20,000/1,50,000

x=$259.47

selling price per unit =$ 259.47 per unit

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