When Molly Lai purchased the Clean Clothes Corner Laundry, she thought that beca

Question

When Molly Lai purchased the Clean Clothes Corner Laundry, she thought that because it was in a good location near several high-income neighborhoods, she would automatically generate good business if she improved the laundry’s physical appearance. Thus, she initially invested a lot of her cash reserves in remodeling the exterior and interior of the laundry. However, she just about broke even in the year following her acquisition of the laundry, which she didn’t feel was a sufficient return, given how hard she had worked. Molly didn’t realize that the dry-cleaning business is very competitive and that success is based more on price and quality service, including quickness of service, than on the laundry’s appearance. In order to improve her service, Molly is considering purchasing new dry-cleaning equipment, including a pressing machine that could substantially increase the speed at which she can dry-clean clothes and improve their appearance. The new machinery costs $16,200 installed and can clean 40 clothes items per hour (or 320 items per day). Molly estimates her variable costs to be $0.25 per item dry-cleaned, which will not change if she purchases the new equipment. Her current fixed costs are $1 ,700 per month. She charges customers $1 .1 0 per clothing item. A. What is Molly’s current monthly volume? B. If Molly purchases the new equipment, how many additional items will she have to dry-clean each month to break even? C. Molly estimates that with the new equipment she can increase her volume to 4,300 items per month. What monthly profit would she realize with that level of business during the next 3 years? After 3 years? D. Molly believes that if she doesn’t buy the new equipment but lowers her price to $0.99 per item, she will increase her business volume. If she lowers her price, what will her new break-even volume be? If her price reduction results in a monthly volume of 3,800 items, what will her monthly profit be? E. Molly estimates that if she purchases the new equipment and lowers her price to $0.99 per item, her volume will increase to about 4,700 units per month. Based on the local market, that is the largest volume she can realistically expect. What should Molly do?

Explanation / Answer

(A) Currently Molly is just having breakeven operations. Thus her current monthly volume is break even operation.

BREAK EVEN POINT ( Sales IN UNITS)= Total FIXED COSTS /CONTRIBUTION PER UNIT

Total fixed costs= 1700

Contribution per unit= 1.1-0.25 = 0.85

Hence Break even Point= 1700/0.85 = 2000

(B) Let us assume the life of the dry clean equipment as 6 years:

Increase in fixed costs every year will be depreciation on the new machinery

Depreciation on new machinery= Value of machinery/ Life of the machinery

=16200/6 = $ 2700 per annum

Thus additional items required to breakeven=Additional Fixed costs/Contribution per unit = 2700/.85 = 3176 units

(C) Operating Income statement:

Sales = 4730

Less Variable costs = 1075

Contribution Margin = 3655

Less Fixed costs = 4400

Operating Income = -745

There will be lossof $745 for next six years.

(D) Total fixed costs=1700

Contribution per unit= 0.99-0.25 = 0.74 (Sales per unit-Variable costs per unit)

Hence, Break even Point= 1700/0.74 = 2297 units

Thus current monthly volume is 2297 units.

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