The Senior Management Team met to discuss the ways of increasing sales volume. The meeting was a response to stiff competition arising from competitive products in the market. The company currently produces three products that generate break-even sales amounting to $5,000,000 at a fixed cost of $1,500,000. The overall break-even in units amounts to 25,000. At the meeting, the production manager suggested that the company should have doubled the number of Office Basic units sold in the following year. This proposal should result in a change in the sales mix and not in the break-even sales units. The proportion of Office Basic will increase while the break-even sales amount to $5,000,000. The company’s overall break-even number of units will still remain at 25,000. Further, the marketing manager suggested that the company should have spent $150,000 on advertising campaigns for the whole year. Based on the analysis in the working section, the proposal will result in an increase in the break-even number of units to 27,500, up from the initial amount of 25,000 units. Further, the break-even sales will increase their costs to $5,500,000. Thus, the sales volume will increase by $500,000 or equivalently by 2,500 units. The Vice President of Operations also suggested that the advertisement should have been used to promote the Office Deluxe model. In his proposal, he suggested that the spending on advertisement should be geared towards encouraging customers to purchase the Office Deluxe model instead of the Office basic model. Based on the analysis in the subsequent sections, the proposal may result in a reduction of the break-even number of units to 16,923, and the break-even sales will amount to $4,139,400. Finally, the manager of Research and Development suggested that the company should have introduced a new product, Office Plus. In his estimation, the introduction of the new product should have affected the sale of the other company’s products. The proposal will result in an increase in the break-even number of units to 26,700, up from 25,000. The break-even sales will also increase to $5,487,500, up from $5,000,000. Thus, it can be observed that the various proposals suggested by the managers yield different results. The proposal by the Vice President of operations yields the most undesired results since it offers a reduction in the volume of sales. However, based on the above comparisons, it can be observed that the proposal of the marketing manager that suggested spending $150,000 on advertisement for the whole year will result in a maximum increase in break-even units and sales in dollars. The sales in units will increase by 2,500 while sales in dollars increase by $500,000.
Break-even Point Analysis
The break-even analysis gives the number of units of output that must be produced and sold to ensure that the total cost incurred equals the total revenue earned. Therefore, it will give the number of units of a commodity that should be produced and sold to enable the business to pay the total cost of production. The concept of break-even analysis aids the management in estimating the minimum number of units that must be produced and sold so that the company can cover both the fixed and variable costs. At the break-even point,
Total revenue (P * Q) = total cost [Variable (VC *Q) + fixed cost]
Information provided
The table presented below shows the information relating to the selling price, variable cost per unit, and fixed cost.
Company’s overall break-even point
The calculation of the overall break-even point will be based on the weighted average of the three products. The formula for calculating the break-even point, in this case, is presented below.
Break – even point = Total fixed expenses
Weighted average selling price-weighted average variable costs
The calculations of the weighted average selling price and weighted average variable costs are presented in the table below.
Calculation of the weighted average selling price
= ($150 * 25%) + ($200 * 62.5%) + ($300 * 12.5%)
= $200
Calculation of the weighted average variable cost
= ($120 * 25%) + ($140 * 62.5%) + ($180 * 12.5%)
=$140
Calculation of the break-even number of units
= $1,500,000 / (200 – 140)
= $1,500,000 / 60
= 25,000 units
The table presented below shows the calculation of the break-even number of units and the break-even sales for each coffee maker model.
Thus, the company’s overall break-even in sales amounts to $5,000,000.
Overall break-even in sales for each product
Based on the table above, the break-even sales for Home Brewer amount to $937,500, Office Basic is $3,125,000, while the same for Office Deluxe amounts to $937,500.
Overall break-even in number of units
Based on the table above, the company’s overall break-even in a number of units is 25,000 units.
The impact of doubling the number of units for Office Basic on the break-even point
The calculations of the new weights are presented in the table below.
Calculation of the weighted average selling price
= ($150 * 15.39%) + ($200 * 76.92%) + ($300 * 7.69%)
= $200
Calculation of the weighted average variable cost
= ($120 * 15.39%) + ($140 * 76.92%) + ($180 * 7.69%)
=$140
Calculation of the break-even number of units
= $1,500,000 / (200 – 140)
= $1,500,000 / 60
= 25,000 units
The table presented below shows the calculation of the break-even number of units and the break-even sales for each coffee maker model.
Based on the calculations above, doubling the units of Office Basic sold will not affect the overall break-even amount of sales.
The impact of spending $150,000 on advertising
Spending of $150,000 on advertising increases the fixed cost. Thus, the new break-even number of units will be computed as illustrated below.
Calculation of the break-even number of units
= ($1,500,000 + $150,000) / (200 – 140)
= $1,650,000 / 60
= 27,500 units
The table presented below shows the calculation of break-even sales.
In order to justify the increase in cost related to the advertising campaign, the sales level must increase by 2,500 units or $500,000.
Reapportionment of units
The calculations of the new weighted average selling price and weighted average variable costs are presented in the table below.
Calculation of the weighted average selling price
= ($150 * 25%) + ($300 * 75%)
= $262.5
Calculation of the weighted average variable cost
= ($120 * 25%) + ($180 * 75%)
=$165
Calculation of the break-even number of units
= $1,500,000 / (262.5 – 165)
= $1,650,000 / 97.5
= 16,923 units
The table presented below shows the calculation of the break-even number of units and the break-even sales for each coffee maker model.
Based on the calculations above, it can be observed that the break-even number of units for Office Deluxe is 10,673 units, up from 3,125 units. This implies that 7,548 customers must purchase Office Basic instead of Office Deluxe in order to attain the break-even number of units.
Addition of a new product line
The calculations will be based on the previous product mix calculated with the three products. This arises from the fact that Karges Coffee Inc. may not change sales combinations within a short period. However, the fixed costs will be increased by $102,000. From the previous calculations,
Weighted average selling price = $200
Weighted average variable cost = $140
Calculation of the break-even number of units
= ($1,500,000 + $102,000) / (200 – 140)
= $1,602,000 / 60
= 26,700 units
Thus, an increase in the amount of fixed cost by $102,000 results in an increase in the overall break-even number of units from 25,000 units to 26,700 units.
From the calculations presented in the table above, the company must produce and sell 3,575 units of Office plus so that it can venture into its products in the following year.