Questions: i. Jack\'s Grocery is manufacturing a \"store brand\" item that has a
ID: 434982 • Letter: Q
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Questions: i. Jack's Grocery is manufacturing a "store brand" item that has a variable cost of BD0.75 per unit and a selling price of BD1.25 per unit. Fixed costs are BD12,000. Current volume is 50,000 units. The Grocery can substantially improve the product quality by adding a new piece of equipment at an additional fixed cost of BD5,000. Variable cost would increase to BD1.00, but their volume should increase to 70,000 units due to the higher quality product. Should the company buy the new equipment? What are the break- even points (BD and units) for the two processes considered in Problem 4? (10 marks) Rubrics for Grading: Computation: Solution- 4 marksExplanation / Answer
We have two scenarios here.
Scenario 1: Normal quality
Here the selling price is BD 1.25 and the variable cost is BD 0.75. The fixed cost is BD 12000 and volume is 50000.
The break-even point is X. We need to solve for X. At X, we will have the total cost = total revenue.
12000 + 0.75X = 1.25X or,
0.5X = 12000 or,
X = 24000 units and the revenue at this point is 24000*1.25 = BD 30000
The total profit will be (1.25-0.75)*50000 – 12000 = 13000
In this scenario the total profit is BD 13000 and the breakeven point is 24000 units.
Scenario 2: Higher quality
Here the selling price is BD 1.25 and the variable cost is BD 1.00. The fixe cost is 12000+5000 = 17000 and the volume is 70000.
The break-even point is X. We shall solve for the value of X where we equate total cost = total revenue
17000 + 1.00X = 1.25X or,
0.25X = 17000 or,
X = 68000 units and the revenue at this point is 68000*1.25 = 85000
The total profit will be (1.25-1)*70000 – 17000 = 500
In this scenario the total profit is BD 500 and the breakeven point is 68000 units
Considering both the scenarios, we notice that the increase in quality and the volume does not result in increase of profit. It reduces instead. Thus the company should not buy the new equipment.
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