Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 59

Profit Planning and Strategic Considerations Because of competitive pressures and potential increases in product quality, your company is evaluating whether it should replace an existing piece of machinery that is used in the manufacture of a key product produced by the company. Because of anticipated decreases in manufacturing cycle time and increases in product quality, you anticipate that, if the company purchases the new machine, it would be able to increase the selling price for the product. Baseline budgeted data are as follows:

Product-Related Information	Existing Machine	New Machine
Sales price per unit	$ 15.00	$ 17.50
Variable cost per unit	$ 12.00	$ 12.00
Fixed costs per month	$100,000	$200,000

Required

1. What is the monthly breakeven volume for each of the two decision alternatives?

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2. Assume that in the past the company’s targeted ratio of operating profit to sales was 12 percent. What sales level, in units per month, would the company have to generate for each alternative in order to meet this stated profitability target?

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3. In evaluating this investment proposal, management is interested in knowing the monthly sales volume (in units) at which the two decision alternatives yield the same operating profit (in dollars). Determine what this monthly volume is. Construct a graph to depict the operating profit equation for each decision alternative. Be sure to fully label the graph, to include the profit equation for each alternative, the breakeven point for each alternative, and the volume level at which the company would be indifferent between the two alternatives.

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4. What strategic factors or considerations might affect the decision as to whether the company should keep or replace the existing equipment?

Step 1 of 7

Fixed costs are costs which does not changes with change in level of production. Variable costs are costs which does changes with change in level of production. Breakeven is point of no profit i.e. where revenue is equal to total costs.