CVP Analysis and Price Changes Scholes Systems supplies a particular type of off

ID: 2433662 • Letter: C

Question

CVP Analysis and Price Changes Scholes Systems supplies a particular type of office chair tolarge retailers such as Target, Costco, and Office max. Scholes isconcerned about the possible effects of inflation on itsoperations. Presently, the company sells 80,000 units for $60 perunit. The variable production costs are $30, and fixed costs amountto $1,400,000. Production engineers have advised management thatthey expect unit labor costs to rise by 15% and unit materialscosts to rise by 10% in the coming year. Of the $30 variable costs,50% are from labor and 25% are from materials. Variable overheadcosts are expected to increase by 20%. Sales prices cannot increasemore than 10%. It is also expected that fixed costs will rise by 5%as a result of increased taxes and other miscellaneous fixedcharges. The company wishes to maintain the same level of profit inreal dollar terms. It is expected that to accomplish thisobjective, profits must increase by 6% during the year. Required: a) Compute the volume in units and the dollar sales levelnecessary to maintain the present profit level, assuming that themaximum price increase is implemented. b) Compute the volume of sales and the dollar sales levelnecessary to provide the 6% increase in profits, assuming that themaximum price increase is implemented. c) If the volume of sales were to remain at 80,000 units, whatprice change would be required to attain the 6% increase inprofits? CVP Analysis and Price Changes Scholes Systems supplies a particular type of office chair tolarge retailers such as Target, Costco, and Office max. Scholes isconcerned about the possible effects of inflation on itsoperations. Presently, the company sells 80,000 units for $60 perunit. The variable production costs are $30, and fixed costs amountto $1,400,000. Production engineers have advised management thatthey expect unit labor costs to rise by 15% and unit materialscosts to rise by 10% in the coming year. Of the $30 variable costs,50% are from labor and 25% are from materials. Variable overheadcosts are expected to increase by 20%. Sales prices cannot increasemore than 10%. It is also expected that fixed costs will rise by 5%as a result of increased taxes and other miscellaneous fixedcharges. The company wishes to maintain the same level of profit inreal dollar terms. It is expected that to accomplish thisobjective, profits must increase by 6% during the year. Required: a) Compute the volume in units and the dollar sales levelnecessary to maintain the present profit level, assuming that themaximum price increase is implemented. b) Compute the volume of sales and the dollar sales levelnecessary to provide the 6% increase in profits, assuming that themaximum price increase is implemented. c) If the volume of sales were to remain at 80,000 units, whatprice change would be required to attain the 6% increase inprofits?

Explanation / Answer

Existing After Increase

Sales

80,000

66.00

Direct materials

25%

7.5

7.5 x 1.1

8.25

Direct labor

50%

15 x 1.15

17.25

variable overheads

25%

7.5

7.50 x 1.20

9.00

Total variable cost

34.50

Contributionmargin

31.50

Fixed cost

1,400,000 x 1.05

1,470,000

Existing profit = [$30(Contribution margin) x 80,000] -$1,400,000 = $1,000,000

a) Compute the volume in units and the dollar sales levelnecessary to maintain the present profit level, assuming that themaximum price increase is implemented.

Volume inunits = (Fixed cost +Desired profit) / Unit Contribution

= (1,470,000+ $1,000,000) /31.50 = 78,413units

Dollar Saleslevel = 78,413 x66 = $5,175,258

b) Compute the volume of sales and the dollar sales levelnecessary to provide the 6% increase in profits, assuming that themaximum price increase is implemented

Volume inunits = (Fixed cost +Desired profit**) / Unit Contribution

= (1,470,000+ $1,060,000) / 31.50 = 80,317units

**Desired profit = $1,000,000 + ($1,000,000 x 6%) =$1,000,000 + $60,000 = $1,060,000

Dollar Saleslevel = 80,317 x66 = $5,300,922

c) If the volume of sales were to remain at 80,000 units, whatprice change would be required to attain the 6% increase inprofits?

Total cost=[80,000 units x $34.50(Variable cost afterincrease) + $1,470,000 (Fixed Cost after increase)

= $2,760,000+$1,470,000 = $4,230,000

Add: Desired profit $1,000,000 x1.06 = $1,060,000

__________

Dollar SalesValue $5,290,000 Unit selling price = $5,290,000 / 80,000

========== = $66.13

Price should be changed from $60 per unit to $66.13 (i.e. 10.22%increase)