Question

Warner Clothing is considering the introduction of a new baseball cap for sales by local vendors. The company has collected the following price and cost characteristics.

Sales price $15 per unit
Variable costs 5 per unit
Fixed costs 50,000 per month

Required:
a. What number must Warner sell per month to break even?
b. What number must Warner sell per month to make an operating profit of $34,000 and $8,400. Assume that the company plans to sell 9,000 units per month. Consider requirements (b), (c), and (d) independently of each other.
c. What will be the operating profit?
d. What is the impact on operating profit if the sales price decreases by 10 percent? Increases by 20 percent?

Answer 1

Answer:

a. 5,000 units

b. 8,400 units and 5,840 units

c. $40,000

d. decrease of operating profit by 22.50 % and increase of operating profit by 45.00%

Explanation:

Breakeven point is level at which a firm makes neither profit nor loss

Break even units = Fixed Costs ÷ Contribution per unit

Break even units = 5,000 units

Units to achieve target profit = Target Profit + Fixed Costs ÷ Contribution per unit

Units to achieve profit of $34,000 = 8,400 units

Units to achieve profit of $8,400 = 5,840 units

Operating Profit = Contribution - Fixed Costs

                           = $40,000

The effect on change of operating profit  can be best shown by calculation of the Degree of Operating Leverage (DOL)

DOL = Contribution ÷ Profit

        = 2.25

Sales decreases of 10 percent = decrease of operating profit by 22.50 % (10 % × 2.25)

Sales Increases of 20 percent = increase of operating profit by 45.00%  (20%× 2.25)