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A business is considering changing its fixed cost to variable cost mix (its operational gearing),
by encouraging some staff to agree to be paid for the hours they actually work, rather than
being fully employed on salaries. If they make this change the C/S ratio will reduce from 0.6
to 0.45 but the fixed cost base will drop 20% to $720,000 in total.
What will be the effect on the breakeven point in revenue terms and the risk profile of the
business?
A The BEP will increase by $100,000 and the risk profile will worsen
B The BEP will increase by $100,000 and the risk profile will improve
C The BEP will reduce by $100,000 and the risk profile will worsen
D The BEP will reduce by $100,000 and the risk profile will improveExisting BEP = 900,000/0.6 = $1,500,000 New BEP = 720,000/0.45 = $1,600,000
Sir please help me get how Existing fixed costs of $900,000 were worked out
The question says that the fixed costs will drop by 20%, which means that they will then be 80% of what they were.
Given that they are dropping to 720,000, it must therefore be that before they are 720,000/80% = $900,000.
(And, of course, it checks. Reduce 900,000 by 20% of 900,000 and you get 720,000 🙂 )
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