Examples - break-even analysis (2)
Student Computers plc. is considering expanding its production of Zip File Readers/Writers, from the 1,600 Zip File units per week it currently sells. The chart below shows its present situation.
The planned expansion of the business will double the production capacity of the factory. Variable costs will decrease by $2 per unit, but fixed costs will increase by $10,000. To sell the additional output, price will be decreased by 10%. If Student Computers go ahead with this project, what will happen to their profitability?
Look at figure 1 above. Capacity was 2,000 units per month, so the new output will be 4,000 units per month.
At 2,000 units sold, TR was $60,000, so:
The price was
The new price will be $27 ($30 less 10%)
Fixed costs were $15,000 and are to rise by $10,000, so they will become $25,000.
Variable costs at an output of 1000 units were $15,000 (TC of $30,000 less $15,000 FC).
Variable cost per unit = $15. New variable cost per unit = $13.
Try drawing the new chart with this information. Fully label your diagram. Jot down some comments on how the changes will affect the firm. Once you have had a go, follow the link below to see the new break-even chart and compare your answer with ours. If it is at all different, then check back through the figures and see where you have gone wrong.
Having drawn the new chart, which will be rewarded in its own right, the next task will probably be an analysis of the effects and come to supported conclusions/judgements.
This information available is as follows:
Further analysis shows the following:
At maximum capacity now, 2,000 units per month, the firm would make $20,000 profit. With the enlarged capacity they will have to sell 3,200 units per month to achieve this level of profit.
They are now operating at 1,600 units per month, or 80% of capacity. Present profit is $12,000 per month. The new factory will have to operate at 2,700 units per month (68% of capacity) to match this profit level.
Conclusions/evaluation - this could be a profitable expansion, but just how many do they expect to sell, and when? It all depends on this information, which is not given.