Break Even Analysis and Planning Case Study

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Costing Case Study

The managers at Pringly Division need to make a decision regarding the pricing of a new product. There are two strategies suggested; the first is for the product to be sold at $170, the second strategy is to increase the marketing and increase the price. In both cases, the firm has a requirement that they will make a $4,000,000 profit. In order to assess which is likely to provide the best opportunity for Pringly each of the pricing strategies may be assessed individually, looking at the number of units required to break even, and then at the number of units that need to be sold to realize the desired level of profit.

$170 Selling Price

If the product is sold at a $170 price, there will be a total of $200,000,000 in fixed costs. Knowing that the variable cost per unit is $30, one can work out the contrition per unit and then how many units need to be sold to break even. This calculation is shown in table

Table 1; Break even point at $170 price

Selling price per unit (a)

Variable cost per unit (b)

Contribution per unit (c) (a-b)

Fixed costs (d)

20,000,000

Unit sales to break even (d/c)

142,857.1429

This shows that 142,858 is the break even point, the unit sales are rounded up, as one cannot sell a fraction of a unit. From this is appears safe that the firm will not make a loss on this products as the probability indicates this level of sales is very comfortable.

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However, the firm does not want to just break even, they also want to make a profit. For this it is necessary to make an adjustment and add the required profit onto the fixed costs, for the money that needs to be generated by the contribution.

Table 2; $4 million profit level at selling price of $170

Selling price per unit (a)

Variable cost per unit (b)

30

Contribution per unit (c) (a-b)

Fixed costs (d)

20,000,000

Required profit (e)

4,000,000

Total contributions required (f) (d+e)

24,000,000

Unit sales to break even (f/c)

171,428.5714

To achieve the desired profit level the firm would need to sell a total of 171,429 units. This is not as comfortable, but according to the probability with 0.5 that 180,000 units could be sold, this is not unreasonable.

The safety margin, which is the upper sales level at the profit desired point, less the break even point has been shown in table 3. This indicates the level of sales (in both units and dollars) that the firm has in terms of a safety margin from the desired point before the product will start to result in a loss.

Table 3; Margin of safety at $170 price point

Units

Revenue

Break even point

145,858

24,795,860

Desired profit level

171,429

29,142,930

Margin of safety

25,571

4,347,070

With an assessment at the $170 pricing point, the next stage is to look at the situation with a pricing point of $200 per.....

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