Yash Vazirani and Hassaan Joosub

GB 202 Project – Part 1

Cost Structure A Cost Type Portion of cost (in $$) that is:

      FIXED VARIABLE

      (state as   (state per

  Product Period a total)   unit)

           

Administration    x 315,000    

Depreciation of production facility x   65,000    

Direct labor x       20

Direct materials  x       15

Machine depreciation x   65,000    

Machine rental x       50

Machine upkeep & repair  x        

(incl. labor, equipment          

to make repairs, & parts)         9

Marketing   x  500,000    

Miscellaneous mfg. overhead x   40,000   34

Office support staff   x 230000    

Other SG&A costs   x 25,000   35

Production supervisor salaries  x   230,000    

Quality control testing x   200,000   26

Rented (outsourced) office   x       

support staff         15

Utilities in production facility x   30,000    6

           

Total costs     1,700,000   210/unit

Question 1:
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

Cost Structure B Cost Type Portion of cost (in $$) that is:

      FIXED   VARIABLE

      (state as   (state per

  Product Period a total)   unit)

           

Administration    x 320,000    

Depreciation of production facility  x   40,000    

Direct labor  x       40

Direct materials  x       15

Machine depreciation x   1,000,000    

Machine rental x   0    

Machine upkeep & repair  x        

(incl. labor, equipment          

to make repairs, & parts)     450,000    

Marketing   x 500,000    

Miscellaneous mfg. overhead  x   250,000   20

Office support staff   x 565,000    

Other SG&A costs    x 150,000   4

Production supervisor salaries  x   200,000    

Quality control testing  x   300,000    

Rented (outsourced) office   x       

support staff          

Utilities in production facility  x   50,000   6

           

Total costs     3,825,000   85/unit

Question 1 Continued:
Question 2:
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

Total Revenue & Costs for Structure A

14,000,000
12,000,000
10,000,000
8,000,000 Total cost A
Dollars

6,000,000 Total revenue A

4,000,000
2,000,000
0
0 5,000 10,000 15,000 20,000 25,000 30,000
Output (units)

Total Revenue & Costs for Structure B

14,000,000
12,000,000
10,000,000
8,000,000 Total cost B
Dollars

6,000,000 Total revenue B

4,000,000
2,000,000
0
0 5,000 10,000 15,000 20,000 25,000 30,000
Output (units)
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

Total Revenue & Costs for Structure A and B

14,000,000

12,000,000

10,000,000
Total cost B
8,000,000
Total revenue B
Dollars

6,000,000 Total cost A

Total revenue A
4,000,000

2,000,000

0
0 5,000 10,000 15,000 20,000 25,000 30,000
Output (units)

Output (units) 0 5,000 10,000 15,000 20,000 25,000 30,000

Total cost B 3,825,000 4,250,000 4,675,000 5,100,000 5,525,000 5,950,000 6,375,000

Total revenue B 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000

Total cost A 1,700,000 2,750,000 4,850,000 4,850,000 5,900,000 6,950,000 8,000,000

Total revenue A 0 2,000,000 4,000,000 6,000,000 8,000,000 10,000,000 12,000,000

Question 3:

Check

Cost Structure A
Sales 3,578,947.37
Contribution margin = $400-$210 - $190
Variable Cost -1,878,947.37
Breakeven volume = Fixed costs/ Contribution margin Contribution Margin 1,700,000
Breakeven volume in units = $1,700,000/190 = 8,947.37 units Fixed Costs -1,700,000

Breakeven Point in Sales Dollars = 400  8,947 = $ 3,578,947.37 Net Income 0

Sales 4,857,142.86

Cost Structure B Variable Cost -1,032,142.86

Contribution Margin 3,825,000

Fixed Costs -3,825,000

Net Income 0
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

Contribution margin = $400-$85 = $315

Breakeven volume – $1,700,000/315 = 12,142.86 units

Breakeven Point in Sales Dollars = $ 4,857,142.86

Question 4:

Cost Structure A

Operating Leverage = Contribution Margin / Net income

Contribution margin = $190 x 12,000 = $2,280,000

Net Income = Revenue – costs

Revenue = $400 x 12,000 units = $4,800,000

Costs = $1,700,000 + ($210 x 12,000) = $4,220,000

Net income = $580,000

Operating leverage = 3.93 times

Cost Structure B

Operating Leverage = Contribution Margin / Net income

Contribution margin = $315 x 12,000 = $3,780,000

Net Income = Revenue – costs

Revenue = $400 x 12,000 units = $4,800,000

Costs = $3,825,000 + ($85 x 12,000) = $4,845,000

Net income = -$45,000

Operating leverage = -84 times

Question 5:
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

      Structure B would be adopted by the company, assuming that it is heading in the direction

of profit maximization. Taking into account that the marketing department is almost 100%

certain that the Apex will sell between 3,000 - 40,000, irrespective of the cost structure; the

logical choice is the cost structure favoring fixed costs. As we already know, the more fixed

costs, the more unstable net come is. The operating leverage of Structure B is 35, in comparison

to the leverage of only 3.52 in Structure A, thus Structure B’s net income will increase 35 times

proportionately to sales.

      On the flip side, there are a few risks. Choosing Structure B means that the operating

leverage behaves consistently with a decrease in sales. For example, when Apex produces 5,000

units, a figure within the range of the company’s predictions, it could stand to lose $2,25

million. Therefore, to effectively operate at this cost structure, the company most produce a

moderate 12,143 units and spend $4,857,142.90 in order to break-even and eventually earn

profit.

      Utilization of a variable cost structure, as opposed to a fixed one does indeed reduce risk;

however, it also reduces the potential to earn profits. A variable cost structure would perhaps

be more suited in a scenario where future prospects are uncertain and maybe the manager is

expecting a decline in revenue. In the earlier operations of Apex, it would seem that the total

costs in contrast with revenues would be producing little, if no profit at all. However, when the

company matures in the near future, under the operating conditions of Structure B, producing

30,000 units could earn a profit of $5,625 million, compared to Structure A’s profit of only $4

million.
Yash Vazirani and Hassaan Joosub
GB 202 Project – Part 1

Question 6:

If Apex were to increase their marketing costs and spend $425,000, their sales would

subsequently increase and there is a 95% chance that the company will sell between 8,000 and 33,000

units. Without the additional spending on marketing, the company had a 95% confidence of selling

between 4,000 and 30,000 units. In the last question, we concluded that Structure B is the riskier choice

but it could potentially be highly profitable with increased sales. Since the spending on marketing will

increase sales substantially, we recommend that the company switch to Structure B and spend the

additional $425,000 on marketing.

Without the additional spending, the company was projected to sell between 4,000 and 30,000

units. The mean of this range is 17,000 units. In that case, Structure A would be much easier to attain for

a new company since the break-even point under that structure was only 8,947 units and the company

would have easily surpassed that figure since it would only have to obtain about half the sales of the

mean of the range. On the other hand, the break-even point for Structure B was 12, 142 units. For a new

small company, it would be difficult to meet the sales needed to reach the break-even point and

although the profits would have been greater with higher sales, the risk of loss was also much higher.

With the additional spending on marketing, the mean of the range is 20,500 units and we believe that

based on this mean, it is highly likely that the company will reach the new break-even point. The new

break-even point for Structure A is 11,184 units ((1,700,000+425,000)/190) and the new break-even

point for Structure B is 13,492 ((3,825,000+425,000)/315). Although the break-even point for Structure B

is still higher, it is highly likely that the company will reach this goal since it is only about 2/3 of the mean

of the range.