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John Moffat.
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gurleenmalhotra
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Ques. A company makes and sells a single product. When sales per month are $6.8 million, Total costs are $6.56 million. When sales per month are $5.2 million, the total costs are $5.44 million. There is a step cost increase of $400,000 in fixed cost when sales are $6.0 million but variable unit costs are constant at all levels of output & sales.
What is the Break-even point of sales revenue per month?
a) $6.0 million
b) There are two break even points $5.64 m & $6.36 million
c) $5.64 mill only
d) $6.36 mill only
John Moffat
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Please do not simply type out full questions and expect to be provided with a full answer,
You will obviously have an answer in the same book in which you found the question, so in future ask about whatever it is in the answer that you are not clear about and then I will explain.
For a change in revenue of $1.6M the change in the total costs is $1.12M but this includes the step up in fixed costs of $0.4M. If there was no step-up then the change in costs would be $0.72M and this would all be variable cost. Therefore the variable costs are 0.72/1.6 = 45% of sales.
Therefore the CS ratio is 100 – 45 = 55%.The total variable cost when sales are 6.8M is 45% x 6.8m = 3.06M, and therefore the fixed cost must be 6.56 – 3.06 = 3.5M. When sales are 5.2M, the fixed costs are therefore 3.5 – 0.4 = 3.1M.
Therefore calculating breakeven revenue in the normal way (i.e. fixed costs / CS ratio), at the lower level breakeven is 3.1M/0.55 = $5.636M. At the higher level, the breakeven is 3.5M/0.55 = $6.363M
gurleenmalhotra
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Apologies for just typing out the question and not asking about the doubt. This will not happen in the future. And thank you for providing the full solution.
gurleenmalhotra
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I didn’t understand one thing. If I use the High Low method formula- Variable Cost Per Unit = (Highest activity cost – Lowest activity cost) / (Highest activity units – Lowest activity units), then I would do $6.56 (highest) – $5.44 (lowest)/ $6.8 – $5.2. Why did we subtract $0.4M from the numerator?
John Moffat
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Because the change in the total cost is partly because of the $400,000 increase in the fixed costs. Only the remainder of the change is due to there being more variable cost.
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