Yash Vazirani and Hassaan Joosub GB 202

8/14/2019 Yash Vazirani and Hassaan Joosub GB 202

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Yash Vazirani and Hassaan JoosubGB 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

1,700,0

00 210/unit


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Question 1:


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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 x1,000,00

0

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

3,825,00

0 85/unit


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Question 1 Continued:

Question 2:

Question 3:

Check

Cost Structure A

Contribution margin = $400-$210 - $190

Breakeven volume = Fixed costs/ Contribution

margin

Breakeven volume in units = $1,700,000/190 =

8,947.37 units

Breakeven Point in Sales Dollars = 400 8,947 = $

3,578,947.37

Output

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

Total cost B

3,825,0

00 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

10,000,00

0

12,000,00

0

Total cost A

1,700,0

00 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

10,000,00

0

12,000,00

0

Sales

3,578,947.3

7

Variable Cost

-

1,878,947.3

7

Contribution

Margin 1,700,000

Fixed Costs -1,700,000

Net Income 0


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Cost Structure B

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

Sales 4,857,142.86

Variable Cost

-

1,032,142.86

Contribution Margin 3,825,000

Fixed Costs -3,825,000

Net Income 0


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Question 5:

Structure B would be adopted by the company, assuming that it isheading 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 Bs

net income will increase 35 times proportionately to sales.

On the flip side, there are a few risks. Choosing Structure B means thatthe operating leverage behaves consistently with a decrease in sales. For

example, when Apex produces 5,000 units, a figure within the range of the

companys 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 doesindeed 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


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operating conditions of Structure B, producing 30,000 units could earn a

profit of $5,625 million, compared to Structure As profit of only $4 million.

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


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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.

Yash Vazirani and Hassaan Joosub GB 202

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