Milano Co. Manufactures and sells three products: product 1, product 2, and prod
ID: 2461140 • Letter: M
Question
Milano Co. Manufactures and sells three products: product 1, product 2, and product 3. Their unit selling prices are product 1, $40; product 2, $30; product 3, $20. the per unit variable cost to manufacture and sell these products are product 1, $30; product 2, $15; and product 3, $8. their sales mix is reflected in ration of 6:4:2. Annual fixed costs shared by all three products are $ 270,000. One types of raw material has been used to manufacture products 1 and 2. The company has developed a new material of equal quality for less cost. The new material would reduce variable costs per unit as fallows: product 1 by $10 and 2 by $5. However, the new material requires new equipmen, which will increase annual fixed costs by $50,000.
Required:
1) If the company continues to use the old material, determine its break-even point in both sales units and sales dollars of each individual product.
2) If the company uses the new material, determine its break-even point in both sales units and sales dollars of each individual product.
Analysis Component
3) What insight does this analysis offer manaement for long-term planning?
Explanation / Answer
Solution:
1)
Annual Fixed Cost = $270,000
Weighted Average Contribution margin = $12
Company’s Break Even Point (in units) = Total Fixed Cost / Weighted Average Contribution margin = $270,000 / $12 = 22,500 Units
Break Even Point
Product 1 = 22,500 Units x 6/12 = 11,250 Units and in dollars = 11,250 Units x $40 = $450,000
Product 2 = 22,500 Units x 4/12 = 7,500 Units and in dollars = 7,500 Units x $30 = $225,000
Product 3 = 22,500 Units x 2/12 = 3,750 Units and in dollars = 3,750 Units x $20 = $75,000
Product 1
Product 2
Product 3
Total
Unit Selling Price
$40
$30
$20
Per Unit Variable Cost
$30
$15
$8
Contribution (Selling Price - Variable Cost)
$10
$15
$12
Ratio (6:4:2)
0.5
0.33
0.17
Weighted Average Contribution
5
5
2
12.00
2)
Break Even Point if company uses new material.
Total New Fixed Cost = $270,000 + $50,000 = $320,000
Company’s Break Even Point (in units) = Total Fixed Cost / Weighted Average Contribution margin = $320,000 / $18.677 = 17,133 Units
Break Even Point
Product 1 = 17,133 Units x 6/12 = 8,566 Units and in dollars = 8,566 Units x $40 = $342,640
Product 2 = 17,133 Units x 4/12 = 5,711 Units and in dollars = 5,711 Units x $30 = $171,330
Product 3 = 17,133 Units x 2/12 = 2,856 Units and in dollars = 2,856 Units x $20 = $57,120
Calculation of New Contribution Margin if company uses new material
Product 1
Product 2
Product 3
Total
Unit Selling Price
$40
$30
$20
Per Unit Variable Cost
$20
$10
$8
Contribution (Selling Price - Variable Cost)
$20
$20
$12
Ratio (6:4:2)
0.5
0.33
0.17
Weighted Average Contribution
10
6.67
2
18.67
3)
For long term planning, the company will continue with the new material. Lesser the break-even point better is the situation.
In case of lesser break-even point, it means company will recover all its fixed cost by selling less units. It is good for company.
Product 1
Product 2
Product 3
Total
Unit Selling Price
$40
$30
$20
Per Unit Variable Cost
$30
$15
$8
Contribution (Selling Price - Variable Cost)
$10
$15
$12
Ratio (6:4:2)
0.5
0.33
0.17
Weighted Average Contribution
5
5
2
12.00