Chapter 13.7, Problem 1LO

Summary Introduction

To determine: The break-even point of the product

Break-even point is where the firm earns no profit and no gains.

Explanation of Solution

Break even analysis is used to determine the amount the product should be sold at a price to earn the sufficient revenue to cover the fixed and variable costs.

The breakeven point:

Company JD has annual pizza sales of $480,000, fixed costs of $190,000, average price of 2-topping pizza, and large of $11 and variable cost of $4 with profit margin of 75%

Formula to calculate the breakeven point:

$\text{Breakeven point (in units)}=\frac{\text{Total fixed costs}}{\text{Gross margin or Contribution margin}}$

Formula to calculate the sales price using margin method:

$\begin{array}{c}\text{Sales price}=\frac{\text{Cost}}{\text{One minus target margin percentage}}\\ =\frac{\$4}{1-0.75}\\ =\frac{\$4}{0.25}\\ =\$16\end{array}$

Hence, the sales price is $16.

This price will cut the sales volume in turn customers of JD Company may be less price sensitive to a quality products.

A cost-volume-profit analysis says that even a small drop in the volume makes the gross profit to increase.

So, company JD considers investing in the area of delivery drivers, online stores, applications and others.

The fetches a fixed cost of additional $100,000. So the new breakeven point will be as below.

The breakeven point will be:

$\begin{array}{c}\text{Breakeven point (in units)}=\frac{\text{Total fixed costs}}{\text{Gross margin or Contribution margin}}\\ \text{Breakeven point (in units)}=\frac{\text{Total fixed costs}}{\text{Selling price}-\text{Variable cost}}\\ =\frac{\$190,000+\$100,000}{\$16-\$4}\\ =\$24,167\text{pizzas}\end{array}$

Hence, the breakeven point is $24,167 pizzas.

Though the BEP was below the last year’s volume and below the revised sales projections, Company JD was confident in revising its average price of pizzas to $16.

This will improve the differentiation from Company D by providing various convenient options on ordering and which will lead to increase in profits.