Anderson Metals manufactures and sells #3 steel rebar that is used in the constr
ID: 2421544 • Letter: A
Question
Anderson Metals manufactures and sells #3 steel rebar that is used in the construction of slabs and driveways. The steel bar not only strengthens the finished concrete product, but it also has unique properties such that its temperature related expansion and contraction matches that of concrete. The product is manufactured and sold in 20' long "sticks." The product is generally produced and sold to match customer demand, and there is not a significant amount of finished goods inventory at any point in time. Summary information for 20X6 is as follows:
Sales were $20,000,000, consisting of 5,000,000 sticks.
Total variable costs were $11,000,000.
Total fixed costs were $8,000,000.
Net income was $1,000,000.
The general economic conditions appear to be deteriorating heading into 20X7, and there is some concern about a reduction in sales volume. The following questions should each be answered independent of one another.
(a) What is the company's break-even point in "sticks?" Can the company sustain a 30% reduction in total volume, and remain profitable?
(b) The company's sole shareholder, Doug Anderson, generally lives off of dividends paid by the business. The business typically declares and pays a dividend equal to 25% of net income. If Doug needs to receive $100,000 in dividends for normal living expenses, what total revenues must Anderson Metals produce in 20X7?
(c) If total volume is expected to decrease by 20%, and the company wishes to continue to produce a $1,000,000 net income by raising the per unit selling price, what revised per stick price must be imposed? Will this strategy necessarily work?
(d) If the company expects a drop in raw material prices to reduce total variable costs to $2 per stick, but all other revenue and cost factors to be unaffected, what will be the revised break-even point in sales and units?
Explanation / Answer
(a) The Company's breakeven point in sticks is equal to a quantity where Sales = Costs Original Scenario Sales were $20,000,000, consisting of 5,000,000 sticks. Revenue per stick is $ 4 Total variable costs were $11,000,000. Variable Cost per stick is $ 2.2 Total fixed costs were $8,000,000. Fixed Costs is $ 8,000,000 Assuming the number of sticks sold as X 4X = 2.2X + 8,000,000 Hence, 1.8X = 8,000,000 or X = 4444444 units to breakeven If the Sales Volume drops by 30% Revised Scenario $ Sales @ $4 per unit for 3,500,000 units (5,000,000 X 70%) 14000000 Less : Variable Costs @ $2.2 per unit for 3,500,000 units 7700000 Less : Fixed Costs 8000000 Net Loss -1700000 Thus, if there is a 30% reduction in volume, the Company cannot remain profitable. Instead, it incurs a loss of $ 1.7 million. (b) Dividends paid to Doug Anderson are 25% of Net Income In the current scenario, the dividend paid to him will be $ 1,000,000 X 25% or $ 250,000. If Doug is to receive $ 100,000 in Dividends, the Net Income earned by the Company will be $ 100,000 / 25% or $ 400,000. Let us assume the total units sold for gaining such net income as X In that case, 4X - 2.2X - 8,000,000 = 400,000 Thus, 1.8X = 8,400,000 or X = 4666667 units At 46,66,667 units, the revenue earned by the Company will be $ 18,666,667. (c) Since the total volume decreases by 20%, the revised volume will be 4,000,000 units The net income for such volume will be $ 1,000,000 Let us assume the revenue per unit as X Therefore, 4,000,000X - (4,000,000 X 2.2) - 8,000,000 = 1,000,000 Hence, 4,000,000X = 1,000,000 + 8,000,000 + 8,800,000 = 17,800,000 Calculating this, X = $ 4.45 per unit The strategy will work to some extent only, as the net income remains the same in both cases. (d) Let us assume the number of sticks required to break-even as X Sales = 4X Variable Costs = 2X Fixed Costs = $ 8,000,000 For breakeven, Sales = Costs Hence, 4X = 2X + 8,000,000 Therefore, 2X = 8,000,000 or X = 4,000,000 units required to breakeven The sales value required to breakeven is 4,000,000 X $4 = $ 16,000,000.