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Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco, and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 91,000 units for $75 per unit. The variable production costs are $40, and fixed costs amount to $1,510,000. Production engineers have advised management that they expect unit labor costs to rise by 15 percent and unit materials costs to rise by 5 percent in the coming year. Of the $40 variable costs, 45 percent are from labor and 25 percent are from materials. Variable overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than 10 percent. It is also expected that fixed costs will rise by 5 percent as a result of increased taxes and other miscellaneous fixed charges. The company wishes to maintain the same level of profit in real dollar terms. It is expected that to accomplish this objective, profits must increase by 6 percent during the year. Required: a. Compute the volume in units and the dollar sales level necessary to maintain the present profit level, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for “Volume in units” to the nearest whole number and round your answer for “Sales” to the nearest whole dollar amount.) b. Compute the volume of sales and the dollar sales level necessary to provide the 6 percent increase in profits, assuming that the maximum price increase is implemented. (Do not round intermediate calculations. Round up your answer for “Volume in units” to the nearest whole number and round your answer for “Sales” to the nearest whole dollar amount.) c. If the volume of sales were to remain at 91,000 units, what price change would be required to attain the 6 percent increase in profits? Calculate the new price. (Round intermediate calculations of unit cost and final answer to 2 decimal places.) New price ___________
Expert Answer
a.
| Volume in units | 88,360 |
| Sales | $ 7,289,700 |
Workings :
Computation of total variable costs after increases:
| Present | Increase | Expected | |
| $ | % | ||
| Selling Price | 75 | 10 | 82.50 |
| Variable Costs : | |||
| Materials | 10 | 5 | 10.50 |
| Labor | 18 | 15 | 20.70 |
| Variable Overhead | 12 | 20 | 14.40 |
| 40 | 45.60 | ||
| Contribution Margin | 35 | 36.90 |
Present profit = 91,000 x $ 35 – $ 1,510,000 = $ 1,675,000.
New fixed cost = $ 1,510,000 x 105 % = $ 1,585,500
Sales in units required to maintain present profits after increase in prices = ( Fixed Cost + Target Profit) / Revised Unit Contribution Margin = $ ( 1,585,500 + 1,675,000) / $ 36.90 = 88,360.43 units
b.
| Volume in Units | 91,084 |
| Sales | $ 7,514,430 |
c.
| New Price | $ 82.53 |
Let the new price be P.
91,000 ( P – 45.60 ) – 1,585,500 = 1,675,000 x 1.06
or P = $ 82.53
