Reyhan Huseynova

Business Management
Thu/Apr/8/2021
Activity: 29.4; 29.5

ACTIVITY 29.4
Location decisions and break-even
The following data have been collected about two possible locations:

[24 marks, 35 minutes]

1 Use the data above to calculate, for each site:

a) Break-even level of output [3]
b) Margin of safety [3]
c) Total maximum profit assuming all units sold [3]

2 Advise the business on which location to choose.

Explain your break-even results in your answer. [10]

3 List five other factors that the business should

consider before making this location decision. [5]

ANSWERS:
1.
Break-even: FC + Safety margin Maximum profit:
unit contribution TR - TC
Site A 60,000/(6 – 3) = 40,000 – 20,000 = 240,000 – 180,000 =
20,000 units 20,000 $60,000
Site B 80,000/(6 – 2.50) = 50,000 – 22,858 = 300,000 – 205,000 =
22,858 units 27,142 $95,000

2.
 Site A has a lower make back the initial investment level of yield and it will,
thusly, be simpler to accomplish a degree of deals at which a benefit can be
made.
 Site B's equal the initial investment level of yield is more than 10% more
than site A's.
 Assuming that the business hopes to work at the most extreme limit
whichever site is picked, at that point site B has a lot more prominent edge of
wellbeing; that is, deals can be up to 27,142 units underneath assumption and
it will, in any case, make back the initial investment.
 Site A has a lot more modest limit and, hence, if deals are solid, the firm
should consider extending sooner than at site B.
 The benefit at site B, accepting everything yield can be sold at $6, is more
prominent, by more than • half, than at site A.
 At the limit, the normal expense of creation at site A is $4.50, while, at site B,
the normal expense is just $4.10.
 If deals are required to be over 40,000, at that point site B will be more
beneficial. The degree of deals at which benefits would be the equivalent can
be determined as follows:

Profit site A = profit site B

Let Q = output and sales
6Q – 3Q – 60,000 = 6Q – 2.5Q – 80,000
3Q – 60,000 = 3.5Q – 80,000
0,5Q = 20,000
Q = 40,000

Answers could focus on issues of hazard related with arriving at the earn
back the original investment level of deals. Much will rely upon the normal
degree of deals on the lookout – in the event that it is over 40,000, site B
offers a more beneficial result.

3.
 capital required to start production at each site
 availability of suitable labour
 impact on existing employees
 room for expansion
 planning issues
 impact on local community

ACTIVITY 29.5
Windcheater Car Roofracks
The sole owner of Windcheater Car Roofracks
needs to expand output as a result of increasing
demand from motor-accessory shops. Current
output capacity has been reached at 5,000 units
per year. Each rack is sold to the retailers for $40.
Production costs are:
■ direct labour $10
■ direct materials $12
■ fixed costs $54,000
The owner is considering two options for expansion:

Option 1: Extend the existing premises, but keep the same

method of production. This would increase fixed
costs by $27,000 per year, but direct costs would
remain unchanged. Capacity would be doubled.
Option 2: Purchase new machinery, which will speed up
the production process and cut down on wasted
materials. Fixed costs would rise by $6,000 per
year, but direct costs would be reduced by $2 per
unit. Output capacity would increase by 50%.
[35 marks, 50 minutes]

1 Drawing the two break-even charts for these options

would assist the owner in making this decision, but
other issues may have to be considered as well.
 ■ Construct break-even charts for these two options.
Identify the break-even point for each.
■ What is the maximum profit obtainable in each case?
■ If demand next year is expected to be 7,000 units,
what would be the margin of safety in both cases?
■ Which option would you advise the owner to
choose? Give both numerical and
non-numerical reasons for your decision. [16]

2 The owner of Windcheater Car Roofracks discovers

that the fixed costs for Option 1 will in fact be 20%
greater than planned. Use a break-even chart to
determine the new break-even point and then
use the equation to verify it. [10]

3 In Option 2 the increase in fixed costs is now

planned to be $8,000 and the direct costs fall
by $2.50 per unit:
■ explain why the direct costs might fall
■ determine the new break-even point. [9]

1.
Case 1
Capacity is K
Pr = 40
VC = 22
FC = 81k

Revenue at 10000
R = Pr x Q
R = 40 x 10000
R = 4000,000

TC = VC + FC
TC = 22 x 10,000 + 81000
TC = $301,000

BEP = FC/Pr – VC
BEP = 81000/40 – 22
BEP = 4500 units
 Case 2
FC = $60000
VC = $20
Capacity = 7500

Revenue = Pr x Q
R = 7500 x 40
R = 300000

TC = VC + FC
TC = 20 x 7500 + 60000
TC = 210000

BEP = FC/Pr – VC
60000/20
BEP = 3000

P = R – TC P = R – TC
P = 400000 – 301000 P = 300000 – 210000
P = $99000 P = $90000

MOS = CO – BEP MOS = CO – BEP

MOS = 7000 – 4500 MOS = 7000 – 3000
MOS = 2500 units MOS = 4000 units
Profit at 7000 units Profit at 7000 units
P = R – TC P = R – TC
R = 7000 x 40 R = 7000 x 40
R = 280000 R = 280000
TC = VC + FC TC = VC + FC
TC = (7000 x 22) + 81000 TC = (7000 x 20) + 60000
TC = 235000 TC = 200000
P = 280000 – 235000 P = 280000 – 200000
P = 45000 P = 80000

1. Option 2 has a much lower break-even level of output.

2. Option 2 has a larger margin of safety.
3. Option 2 may require retraining of employees.
4. Option 1 will result in a significant increase in fixed costs and is more risky.
5. Option 1 can meet increasing demand. Option 2 offers little scope for increasing demand, and
could lead to dissatisfied customers.
6. With option 1, Windcheater can gain a higher market share.
7. Option 1 has a higher maximum profit, but only by 10%. It might be necessary for Windcheater
to reduce the price to sell the extra units.
8. At the expected sales level, option 1 will make a profit of $45,000 compared to $80,000 for option
2.
9. Consideration will need to be given to which option will cause the most disruption to customers
in the short term.
10. The investment cost of each option will need to be considered.
11. The new machinery might have an impact on quality.

Option 2 appears to be a lower-risk option as the break-even level of sales is very

low. However, as sales are expected to be 7,000 units, option 1 has a good margin
of safety, almost 56%, and it offers greater scope for future sales growth. Option 2
could reach capacity very quickly and then the firm would have to think again about
expansion.

2.
Fixed costs will rise to: 1.2 x 81000 = $97,200

Break-even output = fixed costs/unit contribution

= 97,200/18
= 5,400 units

3.
1) Direct costs might fall because:
 The new machinery will reduce the labour costs per unit due to the increased efficiency.
 Less direct labour may be required.
 Materials are being bought in larger quantities and there may be discounts.
 Wastage of materials is reduced due to the new machinery.
 Fewer mistakes may be made.
2)
The break-even point = fixed costs/unit contribution
= 62,000/(40 – 19.50)
= 3,025 units