a company makes an oil level measuring device. the plant is located in Michigan

Question

a company makes an oil level measuring device. the plant is located in Michigan with an average January temperature of 25 degrees. the plant operates 250 days per year. total annual fixed cost for the plant is $775,000. The plant produces 1600 units each work day and sells them for $9.50 giving annual profit of $950,000. An improved process would add $175,000 to the fixed cost but would increase the contribution by $1.20 while allowing a 10% reduction in the selling price which would increase the contribution by steady sales volume in the face of competition. What would be the change in break-even volume be? What happens to the company's profits? How much is it?

Explanation / Answer

>>Current scenario,

Annual fixed cost = $775000

Number of units produced in an year = 250*1600 = 400000 units

Variable cost per unit be x

Total variable cost = 400000x

Total costs = 400000x+775000

Total revenue = 400000*9.50 = 3800000

Profit = Revenue - costs

3800000-775000-400000x = 950000

X= $5.188

Break even volume is when profit = zero

Let break even volume be n

9.5n - 775000 - 5.188n = 0

n = 179730.98 = 179731 (rounding off)

Contribution per units = 950000/400000 = $2.375

>>Improved process

Total fixed costs = 775000+175000 = $950000

Selling price = 0.9*9.5 = $8.55

Contribution is increased by $1.2

Contribution = 2.375+1.2 = $3.575

Total profit = 400000*3.575 = $1430000

Revenue = 8.55*400000 = $3420000

Variable expenses = Revenue- fixed expenses - profits

= 3420000 - 950000 - 1430000 = 1040000

Variable expenses per unit = 1040000/400000 = $2.6

At break even volume, profit = 0

8.55m - 950000 - 2.6m = 0

m = 159663.9 = 159664

Total profits of the company have increased tp $1430000

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