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Topic: Target profit and Break-even Analysis

Charmaine Perito picked up the phone and called her boss, Francis Lloyd Sapinit, the vice president of marketing at COA
Fasteners Corporation: “Francis, I’m not sure how to go about answering the questions that came up at the meeting with
the president yesterday.”

“What’s the problem?”

“The president wanted to know the break-even point for each of the company’s products, but I am having trouble figuring
them out.”

“I’m sure you can handle it, Charmaine. And, by the way, I need your analysis on my desk tomorrow morning at 8:00
sharp in time for the follow-up meeting at 9:00.”

COA Fasteners Corporation makes three different clothing fasteners in its manufacturing facility in Calbayog City. Data
concerning these products appear below:

Velcro Metal Nylon


Normal annual sales volume 100,000 200,000 400,000
Unit selling price P1.65 P1.50 P0.85
Variable cost per unit P1.25 P0.70 P0.25

Total fixed expenses are P400,000 per year.

All three products are sold in highly competitive markets, so the company is unable to raise its prices without losing
unacceptable numbers of customers.

The company has an extremely effective lean production system, so there is no beginning or ending work in process or
finished goods inventories.

Required:
1. What is the company’s over-all break-even point in total sales pesos?
2. Of the total fixed costs of P400,000, P20,000 could be avoided if the Velcro product were dropped, P80,000 if the
Metal product were dropped, and P60,000 if the Nylon product were dropped. The remaining fixed costs of P240,000
consist of common fixed costs such as administrative salaries and rent on the factory building that could be avoided only
by going out of business entirely.
a. What is the break-even point in units for each product?
b. If the company sells exactly the break-even quantity of each product, what will be the overall profit of the
company? Explain this result.
c. Evaluate what should be the strategic decision of the company, which product or products should be kept or
retained.
Solution:

1. Over-all break-even point in total sales pesos:

Velcro Metal Nylon Total


Sales P165,000 P300,000 P340,000 P805,000
Variable expenses 125,000 140,000 100,000 365,000
Contribution margin P 40,000 P160,000 P240,000 440,000
Fixed expenses 400,000
Net operating income P 40,000

CM ratio = Contribution margin = P440,000 = 0.5466


Sales P805,000

Break-even point in = Fixed expenses = P400,000 = P731,796 or P732,000 (rounded)


total sales dollars CM ratio 0.5466

2.

a. Break-even point in units for each product:


Velcro Metal Nylon
Unit selling price P 1.65 P 1.50 P 0.85
Variable cost per unit 1.25 0.70 0.25
Unit contribution margin P 0.40 P 0.80 P 0.60

Product fixed expenses P20,000 P80,000 P60,000

Break-even point in units sold = P20,000 P80,000 P60,000


P0.40 P0.80 P0.60

= 50,000 100,000 100,000

b. Overall profit of the company:

Velcro Metal Nylon Total


Unit sales 50,000 100,000 100,000
Sales P 82,500 P150,000 P85,000 P 317,500
Variable expenses 62,500 70,000 25,000 157,500
Contribution margin P20,000 P 80,000 P60,000 160,000
Fixed expenses 400,000
Net operating income P(240,000)

c. Evaluation: All of the three products should be retained.

Evaluation 1 – drop the two products, Velcro and Metal – Break-evens for the two products of the products are higher
than their normal annual sales. Break-even of the two products the company reduces its fixed expenses by only P100,000
(P20,000 + 80,000). By dropping the two products, the company would go from making a profit of P40,000 to suffering a
loss P60,000.
Allocation of common fixed expenses on the basis of sales revenue:
Velcro Metal Nylon Total
Sales P165,000 P300,000 P340,000 P805,000
Percentage of total sales 20.497% 37.267% 42.236% 100.0%
Allocated common fixed
expense* P 49,193 P89,441 P101,366 P240,000
Product fixed expenses 20,000 80,000 60,000 160,000
Allocated common and
product fixed expenses P 69,193 P169,441 P161,366 P400,000
Unit contribution margin P0.40 P0.80 P0.60

“Break-even” point in units = P 69,193 P169,441 P161,366 P400,00


sold P0.40 P0.80 P0.60
= 172,983 211,801 268,943

*Total common fixed expense × percentage of total sales

Velcro Metal Nylon


Normal annual sales volume 100,000 200,000 400,000
“Break-even” annual sales 172,983 211,801 268,943
“Strategic” decision drop drop retain

Velcro Metal Nylon Total


Sales dropped dropped P340,000 P340,000
Variable expenses 100,000 100,000
Contribution Margin P240,000 P240,000
Fixed expenses 300,000
Net Operating Income P(60,000)

Evaluation 2 – all of the three products should be retained. Two of the products were contributing P100,000 toward
covering common fixed expenses and toward profits.

Velcro Metal Nylon Total


Sales P165,000 P300,000 P340,000 P805,000
Variable expenses 125,000 140,000 100,000 365,000
Contribution Margin 40,000 160,000 240,000 440,000
Product fixed expenses 20,000 80,000 60,000 160,000
Product Segment Margin P 20,000 P 80,000 P180,000 280,000
Common Fixed Expenses 240,000
Net Operating Income P 40,000

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