Break Even Planning and Analysis

¶ … assist the Pringly Division to set up the appropriate pricing for the new product. To achieve this objective, the paper carries out the break-even analysis that will assist the company to fix the appropriate pricing and quantity for the new product.

The company had not been able to achieve its sales target in the past making the company to lose some profits. Thus, the company has decided to reduce its budget to avoid disappointment of the past. Thus, the company has set up different targets to follow and the targets will be evaluated to assist the company to make appropriate decision on the pricing of the new product:

The first strategy is to fix the selling price of the new product to $170 per unit carrying the annual fixed costs of $20,000,000.

The second alternative is to increase the cost of promotion and advertising and set the selling price of the new product to $220. However, the fixed costs will increase to $25,000,000 because the marketing department is adamant that the company needs to increase the advertising costs to achieve the sales target.

The table below reveals the three possibility levels of customer demands.

Estimated demand (units)

Estimated probability (units)*

0.25

0.5

0.25

Financial Analysis

The first step is to set up the selling price, the fixed costs and variable costs per unit.

Selling price

Fixed costs

Variable Cost per unit

$170

$20,000,000

$35

$220

$25,000,000

$35

Thus, the report will provide the break-even points at each level for the first and second strategies as being revealed below:

Break-even point for the first strategy based on the estimated demand of 150,000 units.

Break-even point for the first strategy based on the estimated demand of 180,000 units.

Break-even point for the first strategy based on the estimated demand of 200,000 units.

Break-even point for the second strategy based on the estimated demand of 150,000 units.

Break-even point for the second based on the estimated demand of 180,000 units.

Break-even point for the second strategy based on the estimated demand of 200,000 units.

Thus, the paper calculates the breakeven point at different levels using the data in the table below:

When Estimated Demand = 150,000 units

First Strategy

Second Strategy

New Product

Estimated Costs

Estimated Costs

Variable cost per unit

$35

$35

Fixed cost

20, 000,000

$25,000,000

Selling price per unit

$170

$220

Budget volume

150,000

150,000

When Estimated Demand = 180,000 units

First Strategy

Second Strategy

New Product

Estimated Costs

Estimated Costs

Variable cost per unit

$35

$35

Fixed cost

20, 000,000

$25,000,000.

Selling price per unit

$170

$220

Budget volume

180,000

180,000

When Estimated Demand = 200,000 units

First Strategy

Second Strategy

New Product

Estimated Costs

Estimated Costs

Variable cost per unit

$35

$35

Fixed cost

20, 000,000

$25,000,000.

Selling price per unit

$170

$220

Budget volume

200,000

200,000

Using the excel software; the paper computes the break-even point at each level:

Break-even point at the estimated Demand of 150,000 units

First Strategy

Second Strategy

Break-even point volume

148,148

135,135

Break-even point sale

$25,185,185

$29,729,730

Profits at budgeted volume

$250,000

$2,750,000

Break-even point at the estimated Demand of 180,000 units

First Strategy

Second Strategy

Break-even point volume

148,148

135,135

Break-even point sale

$25,185,185

$29,729,730

Profit at budgeted volume

$4,300,000

$8,300,000

Break-even point at the estimated Demand of 200,000 units

First Strategy

Second Strategy

Break-even point volume

148,148

147,058.82

Break-even point sale

$25,185,185

$29,729,730

Profit at budgeted volume

$7,000,000

$12, 000,000

The results of the break-even analysis reveal that the company will achieve the target profit of more than $4,000,000 with the estimated demand of 180,000 units and 200,000 units using the first and second strategy. However, the company will not achieve the target profit of more than $4,000,000 with the estimated demand of 150,000 units using the first and second strategy. The detailed breakdown of the break even analysis is revealed in the Appendix 1.

The paper uses the financial analysis in the table below to support this assertion:

Profits derived at the First and Second Strategy when the estimated Demand is 150,000 units

First Strategy

Second Strategy

Sales (150,000 x $170)

$25,500,000

Sales (150,000 x $220)

$33,000,000

Variable cost per unit (150,000 x35)

5,250,000

5,250,000

Fixed Costs

20,000,000

25,000,000

Total Costs

25,250,000

25,250,000

30,250,000

30,250,000

Profits

$250,000

$2,750,000

Profits derived at the First and Second Strategy when the estimated Demand is 180,000 units

First Strategy

Second Strategy

Sales (180,000 x $170)

$30,600,000

Sales (180,000 x $220)

$39,600,000

Variable cost per unit (180,000 x35)

6,300,000

6,300,000

Fixed Costs

20,000,000

25,000,000

Total Costs

26,300,000

26,300,000

31,300,000

31,300,000

Profits

$4,300,000

$8, 300,000

Profits derived at the First and Second Strategy when the estimated Demand is 200,000 units

First Strategy

Second Strategy

Sales (200,000 x $170)

$34,000,000

Sales (200,000 x $220)

$44,000,000

Variable cost per unit (200,000 x35)

7,000,000

7,000,000

Fixed Costs

20,000,000

25,000,000

Total Costs

27,000,000

27,000,000

32,000,000

32,000,000

Profits

$7,000,000

$12, 000,000

The results of the financial analysis reveal that the company will achieve the target profits of more than $4,000,000 with the estimated demands of 180,000 and 200,000 units using the first and the second strategy. However, the company will make more profits using the second strategy than the first strategy at the estimated demand of 180,000 units or 200,000 units.

3. Computation of the Margin of Safety

The concept margin of safety is defined as the extent the projected sales exceed the break-even volume or the break-even sales. The formula used to calculate the concept of margin of safety is as follows:

"Margin of Safety = Budgeted Sales ? Break-even Sales"

The paper delivers the calculation the MOS (margin of safety) in the first and second strategy based on the estimated sales of:

150,000 units,

180,000 units and 200,000 units.

Margin of Safety based on the First Strategy and Second Strategy

First Strategy

Second Strategy

Projected Sales (150,000 units)

$25,500,000

$33,000,000

Break-even sales

$25,185,185

$29,729,730

Margin of safety

$314,815

$3,270,270

Margin of safety %

1%

5%

Projected Sales (180,000 units)

$30,600,000

$39,600,000

Break-even sales

$25,185,185

$29,729,730

Margin of safety

$5,414,815

$9,870,270.00

Margin of safety %

9%

12%

Projected Sales (200,000 units)

$34,000,000

$44,000,000

Break-even sales

$25,185,185.00

$29,729,730

Margin of safety

$8,814,815.00

$14,270,270.00

Margin of safety %

13%

16%

Analysis of the MOS reveals that the first strategy with the estimated demand of the 150,000 units will deliver the lowest contribution margin of 1%. However, the second strategy with the estimated of the 200,000 units will deliver the highest contribution margin of 16%.

4. The company should go ahead by investing in the new product because the company will reach the targeted profits of more than $4,000,000 by using the first and second strategy of the estimated sales of 180,000 units and 200,000 units.

5. Large companies producing a range of product could use the analysis to estimate the break-even point for each of product and profit that will be realized for each product. The analysis will assist the company to estimate the contributing margin for each product.