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A firm has discovered that the cost of a raw material will increase.
If nothing else changes what is the effect of this on margin of safety and breakeven point?
A. The margin of safety will decrease and the breakeven point will increase
b.The margin of safety will increase and the breakeven point will increase
C. The margin of safety will decrease and the breakeven point will decrease
D. The margin of safety will increase and the breakeven point will decreaseAnswer A
Fixed costs are constant, but contribution per unit is increasing. Therefore BEP must increase as more sales are needed to match fixed costs.
MoS is how much current production falls before EP is reached. If BEP had increased then the fall to get to BEP must be smaller so MoS has decreased.
Sir if take an example of
Sales are 10, DM is 4, fixed cost are 5000 and targeted profit is 5000. Amended DM is 6.
When DM=4
BEP in first condition is 833.3 whereas units to make targeted profit are 1666.7
When DM=6
In second case, BEP is 1250 and Units made to target profit are 2500.
So BEP is increase but margin of safety is also increasing isn’t it?It depends how the budgeted output is defined. You defined it interest of a target profit whereas the usual way is by units made and sold. Why would units made and sold be set below the maximum possible in the circumstances? More units = more profit.
There is no reason why a target profit is guaranteed to be achievable. Eg if costs rise and there is competiton preventing a rise in prices, you might have to rolerate a lower profit.
Sir, I got your idea but a little bit confusion.
Sir can you give an example as I gave? Your examples are too beneficial.Say initially budgeted output is 10,000 units and BEP is 6000 units, then output can fall 4000 units before BEP is reached. MoS = 4000/10000 = 40%
If material costs rise BEP must rise too….say to 7000 units. MoS is now 10,000 – 7000 = 3,000, ie 30%
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