e quality of the shoes in the face of rising costs would be an unwise marketing move. You expect the cost of shoes to rise by 10% during the coming year. You are tempted to avoid the cost increase by placing a non-cancellable order with a large supplier that would provide 50 000 units of the specified quality for each store at £19.50 per unit. (To simplify this analysis, assume that all stores will face identical demands.) These shoes could be acquired and paid for as delivered throughout the year. However, all shoes must be delivered to the stores by the end of the year. As a shrewd merchandiser, you foresee some r
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Sensitivity and inflation.
As chairman of Walk-About, you are concerned that inflation may squeeze your profitability. Specifically, you feel committed to the £30 selling price, and fear that lowering the quality of the shoes in the face of rising costs would be an unwise marketing move. You expect the cost of shoes to rise by 10% during the coming year. You are tempted to avoid the cost increase by placing a non-cancellable order with a large supplier that would provide 50 000 units of the specified quality for each store at £19.50 per unit. (To simplify this analysis, assume that all stores will face identical demands.) These shoes could be acquired and paid for as delivered throughout the year. However, all shoes must be delivered to the stores by the end of the year.
As a shrewd merchandiser, you foresee some risks. If sales were less than 50 000 units, you feel that markdowns of the unsold merchandise would be necessary to sell the goods. You predict that the average selling price of the leftover units would be £18.00. The regular commission of 5% of revenues would be paid to salespeople.
Required
1 Suppose that actual sales at £30 for the year is 48 000 units and that you contracted for 50 000 units. What is the operating profit for the store?
2 If you had perfect
3 Given actual sales of 48 000 units, by how much would the average cost per unit have had to rise before you would have been indifferent between having the contract for 50 000 units and not having the contract?
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