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The economic assessment of the success or failure of a new business largely depends on such an indicator as costs on investments. The Vanda-Laye Corporation distributing outdoor cooking supplies is a prosperous enterprise, and the company’s recent purchase by new owners indicates its rather high profitability. Nevertheless, as in any business, corresponding calculations should be carried out regularly in order to protect the organization from the financial crisis and to achieve a safe investment plan.
Two alternatives to the development of the corporation proposed for consideration provide different emphasis on fixed costs, which, in turn, is expressed in variable costs. Each of the ways has its own characteristics that need to be taken into account when drawing up a plan for the growth of the corporation’s sales and multiplying its assets. The breakeven quantity is one of the criteria determining the relevance of both alternatives. The cost-volume-profit (CVP) analysis may help to identify the steps that the management of the Vanda-Laye Corporation should take to count on the successful development of the business.
Benefits of the CVP Analysis at the Planning Stage
In the process of planning a new business, the CVP analysis may be useful as an effective tool for assessing the steps that are necessary to obtain a stable profit. According to Said (2016), this algorithm “is based on a set of simplifying assumptions that reduce the complexity of input and output variables to make decision making more tractable” (p. 3).
It means that the detailed assessment of such factors as costs, production volume, and potential profit makes it possible to calculate the specific program of activities and reduce the risks associated with financial investments. In the context of the Vanda-Laye Corporation, this approach is relevant since the two proposed alternatives need to be studied thoroughly to avoid losses, which is unacceptable in a competitive market environment. Therefore, the CVP analysis is a valuable managerial tool for assessing the rationality of each subsequent step.
Breakeven Quantity for the Investment Alternatives
In order to calculate the breakeven quantity for both the development alternatives, it is essential to take into account such criteria as variable costs, fixed costs, and total assets. Like Park, Lee, Doo, and Yoon (2016) argue, “the break-even point is where the total contribution margin equals the total fixed costs” (p. 159). In other words, if the volume of goods produced does not affect the share of profits negatively, the company will be profitable.
With regard to the strategies of the Vanda-Laye Corporation, in the first case, the company spends $2.20 for the production of one unit, and in the second case, this figure is $2.70. According to the first alternative, the volume of fixed costs is $80,000 and based on the second way, it is $30,000. Since the total assets in both strategies are equal to $350,000, by calculation, it can be determined that the number of units of goods produced will be approximately 122,727 and 118,518, respectively. It means that by adhering to the first alternative, it is possible to realize a larger volume of products, which is a more profitable strategy.
Breakeven Differences Analysis
When analyzing the breakeven indicators, it can be noted that, in accordance with the first alternative, the Vanda-Laye Corporation will be able to produce a larger volume of goods in a certain within money limit compared to the second one. Despite the fact that the indicator of the fixed cost is higher in the first strategy, the share of variable costs affects the final result significantly, and this parameter is lower than in the second strategy.
While taking into account the fact that the corporation determines the price of $3.45 per item and adheres to the first alternative, it will be able to earn about $423,400, while in the second case, the profit will be equal to approximately $408,900. These figures confirm the relevance of higher fixed costs and lower variable costs.
Pros and Cons of the Alternatives
Based on the considered calculations and results, I would recommend the Vanda-Laye Corporation to resort to the first development alternative since it provides for a greater share of profit. Nevertheless, its main drawback is that fixed costs are high, which requires sufficient resources. The second alternative can bring a little less profit; however, it does not imply a large cost base, and assets may be used more freely, which is its advantage. According to Handley and Limao (2015), a key factor in the success of any enterprise is a stable profit. Therefore, the use of the first alternative is more rational in the context under consideration.
Applying the cost-volume-profit analysis can be useful for planning the financial performance of the Vanda-Laye Corporation and evaluating its development. The calculation of the breakeven quantity is the procedure that provides relevant information on the rationality of two possible strategies. The final profit is an important criterion for the success of any enterprise. Based on the assessment conducted, the first alternative is more financially advantageous; therefore, its use in the company is more appropriate.
Handley, K., & Limao, N. (2015). Trade and investment under policy uncertainty: Theory and firm evidence. American Economic Journal: Economic Policy, 7(4), 189-222. Web.
Park, W., Lee, K., Doo, S., & Yoon, S. S. (2016). Investments for new product development: A break-even time analysis. Engineering Management Journal, 28(3), 158-167. Web.
Said, H. A. (2016). Using different probability distributions for managerial accounting technique: The cost-volume-profit analysis. Journal of Business and Accounting, 9(1), 3-24.