Paul\'s Medical Equipment Company manufactures hospital beds. Its most popular m
ID: 2456483 • Letter: P
Question
Paul's Medical Equipment Company manufactures hospital beds. Its most popular model, Deluxe, sells for $5,000. It has variable costs totaling $2,800 and fixed costs of $1,000 per unit, based on an average production run of 5,000 units. It normally has four production runs a year, with $500,000 in setup costs each time. Plant capacity can handle up to six runs a year for a total of 30,000 beds. A competitor is introducing a new hospital bed similar to Deluxe that will sell for $4,000. Management believes it must lower the price to compete. Marketing believes that the new price will increase sales by 25% a year. The plant manager thinks that production can increase by 25% with the same level of fixed costs. The company sells all the Deluxe beds it can produce. Question 1: What is the annual operating income from Deluxe at the price of $5,000? Question 2: What is the annual operating income from Deluxe if the price is reduced to $4,000 and sales in units increase by 25%?3:What is the target cost per unit for the new price if target operating income is 30% of sales.
Explanation / Answer
Fixed cost is calculated on the basis of the normal production level. The company runs four production runs normally per year. Each production run produces 5000 units. Total number of units normally produced and sold = 4 * 5000 = 20000 units.
Fixed cost per unit = $1000
Tital fixed cost = 20000 * $1000 = $20000000 per year.
set up cost per production run = $500000
Total set up cost for 4 production run = 4 * 500000 = $ 2000000
Selling price per unit = $5000
variable cost per unit = $2800
Contribution per unit = $5000 - $2800 = $2200
Answer to question 1:
Total contribution from sale of 20000 units @ $2200 per unit = $44000000
Less:
Set up cost $2000000
Fixed cost $20000000
$22000000
$22000000
2)
The sales has been increased by 25% = 25% of 20000 = 5000 units.
Total number of units produced and sold = 20000 + 5000 = 25000 units
Number of production run = 25000 units / 5000 units = 5
Total set up cost = $50000 * 5 = $2500000
Fixed cost will remain same, that is = $20000000
Selling price per unit = $ 4000
Variable cost per unit = $4000 - $2800 = $1200
Income Statement
Total contribution from 25000 units @ $1200 per unit = $30000000
Less:
Set up cost: $ 2500000
Fixed cost $20000000 $22500000
Net operating profit $7500000
3)
Target profit = 30% of sales = 0.30 * 100000000 = $30000000
Contribution required to earn $30000000 profit
= Fixed cost + set up cost + required profit
= $20000000 + $2500000 + $30000000
= $ 52500000
Required Contribution per unit = $52500000 / 25000 units = $2100
variable cost per unit = $2800
therefore target selling price to earn 30% profit on sales = $2100 + $2800 = $4900.