Lecture Illustration COST VOLUME PROFIT ANALYSIS COLA Ltd buys Vitamin Water in unmarked 1 litre plastic bottles,

attaches its own label to the bottles, and then sells the bottles to restaurants for $3 each. Costs at present for the business are as follows: Advertising $5 000 per year Vitamin Water $1.20 per bottle Rent $10 000 per year Labelling $0.30 per bottle Managers salary $45 000 per year Delivery costs $0.30 per bottle
(a)What is the contribution per unit at present and what is the significance of this figure?

Fixed Costs Advertising $5 000 per year Rent $10 000 per year Mgrss salary $45 000 per year Selling Price Less Variable Costs Vitamin Water Labelling Delivery costs Contribution margin

Variable Costs

Vitamin Water $1.20 per bottle Labelling $0.30 per bottle Delivery costs $0.30 per bottle

$3.00 ($1.20) ($0.30) ($0.30) $1.20 = $60,000 ($3.00 $1.80 = $1.20) = 50,000 bottles
$150,000 90,000 60,000 60, 000 $0

(b) How many bottles must be sold each year to break even?

Fixed costs Contribution Margin per unit

Income (50,000 x $3) Less Variable Costs (50,000 x $1.80) Contribution Margin (50,000 x $1.20) Less fixed costs Profit

(c) The company expects to sell 120 000 units in the coming year. What is the margin of safety at this level of activity? How much profit will the business make for the year if its estimated level of activity is accurate? If sales are 120,000 units what is the margin of safety and Estimated profit. Margin of Safety excess sales over breakeven 120,000 bottles less 50,000 bottles = 70,000

Profit at 120,000 bottles 70,000 bottles x $1.20 = $84,000 Income Statement @ 120,000 units Income (120,000 x $3) Less Variable Costs (120,000 x $1.80) Contribution Margin (120,000 x $1.20) Less Fixed costs Profit

$360,000 216,000 144,000 60, 000 $ 84,000

(d)The company estimates that if it reduced the selling price by $0.20 per bottle, spent an additional $10 000 on advertising for the year, and improved the labels on the bottles (at an extra cost of $0.10 per bottle), sales for the year would rise to 150 000 units. With supporting calculations, show whether the company should make these changes. Revised pricing and costing Current Revised Sales price $ 3.00 $ 2.80 Variable costs $1.80 $1.90 Contribution margin $1.20 $0.90 Fixed Costs $60,000.00 $70,000.00 New breakeven point = $70,000 / .9 = 77,777.77 bottles Profit at 120,000 units x $1.20 Profit = (150,000 77,777.77) x $0.9 = $84,000 = $65,000 decrease of $19,000

(e) Pepsi Ltd, a competitor of Cola Ltd from interstate, sold 100 000 1 litre bottles of Vitamin water last year at $4 per unit and made a profit of $50,000. This year the costs of Pepsi Ltd remained the same, it sold 120,000 units at the same price, and made a profit of $80 000. Determine the total fixed costs per year and the total variable cost per unit of Pepsi Ltd. Current Proposed cost structure cost structure Fixed costs $ 60,000.00 $ 15,000.00 Selling price 3.00 3.00 Variable costs 1.80 2.30 Contribution Margin 1.20 0.70 Point of Indifference where cost is the same =Change in fixed costs Change in Contribution margin = 45000/.5 = 90000bottles (f) Cola Ltd could avoid the managers salary costs by paying her $0.50 for every bottle sold. In what circumstances would Cola Ltd benefit from switching to this arrangement? (revert to original cost scenario) Sales Less variable costs Contribution margin Less Fixed Costs Profit above 90000 bottles below 90000 bottles Current $ 270,000.00 $ 162,000.00 $ 108,000.00 $ 60,000.00 $ 48,000.00 increase 1.20 decrease 1.20 Proposed $270,000.00 $207,000.00 $ 63,000.00 $ 15,000.00 $ 48,000.00 increase 0.70 decrease 0.70

Operating gearing discussion on COLA Ltd. Part (f) This illustrates the point that businesses with higher operating gearing have higher levels of fixed costs are riskier sell more units before fixed costs are covered. have a higher contribution per unit,

Yet, as long as break-even is achieved, each unit sold after that will contribute more to profit than it would for a business with low operating gearing. (g) Cola is to introduce new product a sports Vitamin water which will use the existing 1 litre bottles. The only additional variable cost is the additional of the sport supplement at $0.20 per bottle. Other variable costs are as per the original cost scenario for the 1 litre standard bottle. Fixed costs will increase by $10,000 per year due to both administrative and production changes. The sales mix is expected to be 75% standard and 25% sport. What is the new breakeven point for Cola Ltd.? Sales price Variable costs Contribution margin Sales mix Standard Water $3.00 $1.80 $1.20 75% Sports Supplement $3.50 $2.00 $1.50 25%

Weighted Margin ($1.20 x 75%) 0.90 ($1.50 x 25%) .375 Weighted average contribution margin = 0.90 + .375 =$1.28 (rounded Breakeven point = $60,000 + 70,000 / $1.28 = 54,687.5 bottles

By bottle type Standard 75% - 41,015.6 Sport 25% - 13,671.8 Sales $ Less Variable CostsContribution Margin Less Fixed Costs Profit Standard 123,046.88 73,828.125 49,218.75 Sports Total 47,851.56 27,343.75 20,507.81 69,726.56 70,000.00 ($ 273.44)