Milano Co. Manufactures and sells three products: product 1, product 2, and prod
ID: 2461882 • 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 management for long-term planning?
Explanation / Answer
Solution:
Step 1: Compute break-even in composite units—
Break-even in composite units = Fixed costs/Contribution margin per composite unit
= $270,000 / $144*
= 1,875 units
* To compute the contribution margin per composite unit
Unit Sales Price
Unit Variable Costs
6 units of Product 1
@ $40 per unit......................................................
@ $30 per unit......................................................
$240
$180
4 units of Product 2
@ $30 per unit......................................................
@ $15 per unit......................................................
120
60
2 units of Product 3
@ $20 per unit......................................................
@ $8 per unit........................................................
40
____
16
Selling price of a composite.....................................
Variable cost of a composite....................................
$400
$256
Thus:
Contribution margin per composite unit = $400 - $256 = $144
Contribution margin ratio = $144 / $400 = 36%
Step 2: Compute break-even in individual product unit sales
Unit sales of Product 1 at break-even: 1,875 x 6 = 11,250 units
Unit sales of Product 2 at break-even: 1,875 x 4 = 9,375 units
Unit sales of Product 3 at break-even: 1,875 x 2 = 3,750 units
Step 3: Compute break-even in individual product dollar sales
Dollar sales of Product 1 at break-even: 11,250 units x $40 = $450,000
Dollar sales of Product 2 at break-even: 9,375 units x $30 = $281,250
Dollar sales of Product 3 at break-even: 3,750 units x $20 = $75,000
2.
Step 1: Compute break-even in composite units
Break-even in composite units = Fixed costs/Contribution margin per composite unit
= ($270,000 + $50,000) / $224*
= 1,429 units
*To compute the contribution margin per composite unit
Unit Sales Price
Unit Variable Costs
6 units of Product 1
@ $40 per unit......................................................
@ ($30 - $10) per unit...........................................
$240
$120
4 units of Product 2
@ $30 per unit......................................................
@ ($15 - $5) per unit.............................................
120
40
2 units of Product 3
@ $20 per unit......................................................
@ ($8 – $0) per unit..............................................
40
____
16
Selling price of a composite.....................................
Variable cost of a composite....................................
$400
$176
Thus:
Contribution margin per composite unit = $400 - $176 = $224
Contribution margin ratio = $224 / $400 = 56%
Step 2: Compute break-even in individual product unit sales
Unit sales of Product 1 at break-even: 1,429 x 6 = 8,574 units
Unit sales of Product 2 at break-even: 1,429 x 3 = 7,145 units
Unit sales of Product 3 at break-even: 1,429 x 5 = 2,858 units
Step 3: Compute break-even in individual product dollar sales
Dollar sales of Product 1 at break-even: 8,574 units x $40 = $342,960
Dollar sales of Product 2 at break-even: 7,145 units x $30 = $214,350
Dollar sales of Product 3 at break-even: 2,858 units x $20 = $57,160
3. In this case, when a business invests in fixed assets, there is an increase in the risk level. Investments in fixed assets can reduce variable costs which reduces the break-even point making it easier to make profit with fewer sales.
Unit Sales Price
Unit Variable Costs
6 units of Product 1
@ $40 per unit......................................................
@ $30 per unit......................................................
$240
$180
4 units of Product 2
@ $30 per unit......................................................
@ $15 per unit......................................................
120
60
2 units of Product 3
@ $20 per unit......................................................
@ $8 per unit........................................................
40
____
16
Selling price of a composite.....................................
Variable cost of a composite....................................
$400
$256