Break-Even Point Analysis
Compute break-even at each level
Break-even point is a cost-volume-profit analysis method that is meant to indicate a point at which a project will neither make profit nor incur a loss (Tsorakidis, 2009). At this point, the project is at equilibrium and the revenue earned is equal to the fixed and variable cost incurred. The breakeven point of this question is analyzed in the attached excel document (as requested). The BEP of first strategy is 148, 148 units and the second one is 151, 515 units
Is the company likely to achieve its desired target profit of $4,000,000 or more? Support your discussion with financial analysis.
Yes. The company is in a position to make $4,000,000 or even more as the analysis in the attached excel document shows. If the company adopts the first strategy, it will only need to produce 177,778 units of the new product to make a profit of $4,000,000. On the other hand, if the company adopts the second option, 175,758 units of the new product will be necessary to make a profit of $4,000,000.Anything below this figure of units, in both cases, will hinder the company from achieving this targeted profit($4,000,000). Therefore, given the probable level of demand, only that level of 150,000units will not amount to a profit of $4,000,000.
Compute the margin of safety and explain the meaning of the number derived.
Margin of safety is difference between budgeted or actual sales and the sales required to meet the break-even point (Walther, 2010). If that difference is multiplied by the contribution margin, the result is profit/loss of the product .The computation of margin of safety, for this case, is provided in the attached excel document. For the first strategy, the figures indicate that at a demand of 150,000 units, 180,000 units and 200,000 units, the margin will be 1,852 units, 31,852 units and 51,852 respectively. In this case, the margin of safety is positive in all levels of demand and therefore, at all levels, the new product will arrive in a profit. For the second strategy, the figures indicate that at a demand of 150,000 units, 180,000 units and 200,000 units, the margin will be -1515 units, 28,485units and 48,485units respectively. In this case, the margin of safety is negative for the demand of 150,000 units is negative and positive on others. Therefore, on the probability that the demand will be of 150,000 units, the new product should be dropped.
Should the company go ahead with the new product?
With the BEP of the first strategy being 148, 148 units, at all levels of demand the production of the new product should be upheld. Since the probabilities are high, the company should go ahead and produce it. For the case of second strategy, where the BEP is 151,515 units, caution should be exercised where the demand is 150,000 units. This is because there is a deficit of 1,515 units to hit the BEP units. However, generally, there is a higher probability that the demand will go beyond 150,000 units. Therefore, even in this case, the new product should be produced.
Would this type of analysis be useful to a large company with a wide range of products?
All that matters is the demand of the new product and the break-even point of those products. Where the BEP matches or supersedes the demand of the product and there is a probability of improvement in demand, the analysis is viable for a large company wide range of product. However, it should be noted that the fixed cost must be allocated to the range of products. Allocation of the fixed cost to all products in the group is necessary for the analysis to be viable. If any cost cannot be apportioned, then, the analysis will be misleading and the company should not adopt the analysis.
ROI (return on investment) and residual income are two other methods that can be helpful for this type of decision. Could they be applied in this situation? Support your answer with financial analysis
Return on Income is a feasible method for cost-benefit-profit analysis. It shows the profit percentage one expects from a project. However, for an informed decision, whether to produce or abandon a new product, to be arrived at, it must be compared with cost of income. Thus, without the cost of income, one will not be able to make a decision. In this case, the cost of income is not provided. Therefore, although we know that at demand of 150,000 units, 180,000 units and 200,000 units the ROI will be 0.01, 0.16 and 0.26 respectively and for first strategy (0.008), 0.15 and 0.25 respectively, it is not possible to come up with a decision criterion whether to accept or abandon the new product. This is because the cost of income is not provided.
When it comes to the residue income method, it is possible to come up with a decision criterion. However, one cannot tell the point at which the profit will start to be realized. It therefore provides a weak decision criterion.
Tsorakidis, N. (2009). Break-Even Analysis. Retrieved from: http://bookboon.com/en/business/finance/break-even-analysis-1
Walther, l. (2010). Chapter Eighteen. Cost-Volume-Profit and Business Scalability. Retrieved (including video lecture) from http://www.principlesofaccounting.com/
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