1. What are the assumptions implicit in Bill French’s determination of his company’s break-even point? * He has assumed that there is just one breakeven point for the firm (by taking the average of the 3 products). * He has also assumed that the sales mix will remain constant. Total revenue and total expenses behave in a linear manner over the relevant range. * Since the capacity is being expanded to increase production of Product C, it could be assumed that this increase should be allocated to this product. Production of Product A is to be scaled down, but its level of fixed costs has been assumed to be unchanged. * Constant dividends are paid out to the company’s stockholders. * Labor union will not significantly affect cost structure. No substantial changes in product prices.
2. On the basis of French’s revised information, what does next year look like?
a. What is the break-even point?
The break even unit for the aggregate production is 1,035,686 units. Calculation of the break even points using the new estimates: Breakeven points have been calculated using the formula: Breakeven number of units = Fixed costs / Contribution margin per unit, where Contribution margin per unit = Selling price – Variable cost per unit
b. What level of operations must be achieved to pay the extra dividend, ignoring union demands? To pay the extra dividend of 50% and to retain the profit of 150,000 we need to have the profit after taxes as 600,000. As half of the revenues go to the government as taxes therefore the total revenues before tax deduction should be equal to 1,200,000.
c. What level of operations must be achieved to meet union demands, ignoring bonus dividends?
d. What level of operations must be achieved to meet both union demands & bonus dividends?
3. Can the break-even analysis help the company decide whether to alter the existing product emphasis? What can the company afford to invest for additional “C” capacity? Break even analysis can be used to decide whether to alter the existing product emphasis or not. In this case, based from previous year’s data, it is not feasible to manufacture product C at 2.40 / unit. Below table provides checking whether the company can afford to invest in additional C capacity.
4. Calculate each of the three products’ break even points using Exhibit 3. Why is the sum of these three volumes not equal to the 1,100,000 unit’s aggregate break-even volume? The sum of three break even volumes does not equate the aggregate break even volume because of varying fixed costs. It is illustrated in the below table:
Question 5: Is this type of analysis of any value? For what can it be used?
Break-Even analysis explains the relationship between cost, production, volume and returns. It can be extended to show how changes in fixed cost, variable cost, commodity prices, revenue will affect profit levels and break even points. Break even analysis is most useful when used with partial budgeting, capital budgeting techniques. The break even analysis helps understand and formulate the relationship between costs (fixed and variable), output and profit. The technique can be used to set sales targets and/or prices to generate target profits. In a wide product range, the analysis helps to find out which products are performing well and which are leading to losses .It is also versatile enough to include items like donations, wage increases, etc. that directly or indirectly affect costs.