Break-Even in Units, After-Tax Target Income, CVP Assumptions Campbell Company m
ID: 3121789 • Letter: B
Question
Break-Even in Units, After-Tax Target Income, CVP Assumptions Campbell Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Campbell developed its 2013 business plan based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $120,000. Campbell’s after-tax profit objective was $225,000; the company’s effective tax rate is 40 percent.
While Campbell’s sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the 2013 after-tax profit projection would not be reached unless some actions were taken. Campbell’s president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president: A. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast. B. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted. C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.
Required:
1. Determine the number of units that Campbell Company must sell in order to break even assuming no changes are made to the selling price and cost structure. _________________ units
2. Determine the number of units that Campbell Company must sell in order to achieve its after-tax profit objective. _________________ units
3. Determine which one of the alternatives Campbell Company should select to achieve its annual after-tax profit objective. Alternative B Be sure to support your selection with appropriate calculations. After-tax profit Alternative A $ _________________ Alternative B $ _________________ Alternative C $ _________________
4. The precision and reliability of CVP analysis are limited by several underlying assumptions. Identify at least four of these assumptions.
Explanation / Answer
1. Selling Price = 400/ unit
Variable cost = 200/ unit
Fixed cost = 120,000
To have break even sales,
Contribution = fixed cost
Contribution = (400 -200) * X, Where X is the number of units to be sold.
Hence,
200 *X = 120,000
Therefore, X = 120,000/ 200 = 600 units.
Hence in order to break even, compony must sell 600n units.
2. After tax profit objective = 225,000
Effective tax rate = 40%
After tax Profit = Contribution after tax - Fixed cost
That is ,
225,000 = 200* X* 60% - 120, 000
Therefore 120X = 225,000 + 120,000= 345, 000
That is, X = 345,000/ 120 = 2875 units.
3. Number of sales during the first 5 months = 350
Alternative A
Variable cost = 200-25 = 175
Selling price = 400 - 30 =370
Sales of the reaining year = 2200
After tax Profit = [ 200 * 350 + (370-175)*2200]* 60/100 - 120,000 = 179400
Alternative B
Selling price = 400-40= 360
Variable cost = 200
Sales for the remaining period = 2700
Therefore, Profit after tax = [200*350 + (360-200)*2700]*60/100 - 120,000 = 301200 - 120000
= 181200
Alternatice C
Selling price = 5% decrease from 400 = 380
Variable price = 200
Fixed cost = 120,000-10,000= 110,000
Sales for the remaining period = 2000
After tax profit = [200*350 + (380-200)*2000]*60/100 - 110,000
= 430000*60/100 - 110,000
= 148,000
To achieve its after tax profit objective, the company should select alternative B, since it provides the highest return.
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