Based on Profit-Maximization Analysis, What Level of Output Should You Recommend to the Ceo?
By: mumijojo • May 4, 2018 • Case Study • 1,032 Words (5 Pages) • 1,051 Views
Question 4: Based on profit-maximization analysis, what level of output should you recommend to the CEO?
Quantity | Price per unit | TR(P*Q) | TC(F+V) | MR | MC | MR-MC | Profit |
200 | $70,000 | $14,000,000 | $13,000,000 | 0 | 0 | 0 | $1,000,000 |
250 | $66,000 | $16,500,000 | $14,500,000 | $2,500,000 | $1,500,000 | $1,000,000 | $2,000,000 |
300 | $64,000 | $19,200,000 | $15,400,000 | $2,700,000 | $900,000 | $1,800,000 | $3,800,000 |
350 | $59,000 | $20,650,000 | $17,100,000 | $1,450,000 | $1,700,000 | $-250,000 | $3,550,000 |
400 | $52,000 | $20,800,000 | $19,000,000 | $150,000 | $1,900,000 | -$1,750,000 | $1,800,000 |
TR: Total Revenue, TC: Total Cost, MR = Marginal Revenue, MC = Marginal Cost, F=Fixed cost
From my calculation above, the most effective price point and quantity that maximize the shareholder’s value is at 300 units of Android01. This is because we can see that the fixed cost, which is the production overhead cost (indirect cost) will only be maximized and optimized at 300 production level. At this level, we see that our total variable cost is $14,400,000 and our fixed cost will be $3,333 per unit ($1,000,000 divided by 300 units). At this level our profit margin is 25% ($12,667 divided by $51,333). But if any of the variable changes i.e. if we assume that the variable cost increases by 5% but fixed cost remains the same. This will present a different result to management. We can see that with the assumption on inflationary pressure of 5% on direct costs, this will wipe out part of the potential gross profit. And the same time it also tells management that production at this level (300 units) will still maximize profitability to the business.
Quantity | Price per unit | TR(P*Q) | V | 5% Inflation | TC(F+V) | MR | MC | MR-MC | Profit |
200 | $70,000 | $14,000,000 | $60,000 | $63,000 | $13,600,000 | 0 | 0 | 0 | $400,000 |
250 | $66,000 | $16,500,000 | $54,000 | $56,700 | $15,175,000 | $2,500,000 | $1,575,000 | $925,000 | $1,325,000 |
300 | $64,000 | $19,200,000 | $48,000 | $50,400 | $16,120,000 | $2,700,000 | $945,000 | $1,755,000 | $3,080,000 |
350 | $59,000 | $20,650,000 | $46,000 | $48,300 | $17,905,000 | $1,450,000 | $1,785,000 | ($335,000) | $2,745,000 |
400 | $52,000 | $20,800,000 | $45,000 | $47,250 | $19,900,000 | $150,000 | $1,995,000 | ($1,845,000) | $900,000 |
But management should continue to track and observe the marginal cost level as this might change on the long run.
Question 5: Using the above information, prepare a budget for May 20X8 stating the total cost.
MiniY: Production Cost | Budget April 20X8 | April Cost Per unit | May Cost Per unit | Budget May 20X8 |
Production–Units of MiniY | $3,000 |
|
| $3,200 |
Components cost (variable) | $24,000,000 | $8,000 | $8,000 | $25,600,000 |
Labor cost (variable) | $13,500,000 | $4,500 | $4,500 | $14,400,000 |
Rent (fixed) | $6,000,000 | $2,000 | $1,875 | $6,000,000 |
Depreciation (fixed) | $6,000,000 | $2,000 | $1,875 | $6,000,000 |
Other (fixed) | $2,000,000 | $667 | $625 | $2,000,000 |
Total | $51,500,000 |
|
| $54,000,000 |
Product Cost Per unit | $17,167 | $17,167 | $16,875 | $16,875 |
In answering this question, I want to assume that the component fixed cost element per unit will remain the same in May because of the economics of scale advantage in April i.e. the fixed overhead cost, which does not change with the level will remain the same, hence fixed overhead cost per unit will reduce because production level has increased by 6.6% in May 20x8. This will result in a lower rent fixed cost per unit from $2,000 to $1,875, Depreciation will change from $2,000 to $1,875 and other fixed cost will also change from $667 to $625.
Based on our budget forecast for May 20x8 we can see that our overall cost of production will reduce by 6.6% per unit because of the fixed cost element that remains the same because it does not vary in cost as level of production changes as a result of our assumptions above. the table above shows what our expected production cost will be and expected volume. Other fixed cost is expected to remain the same as well. But the whole picture presented can change if we make some other assumptions that we have not been given. In a scenario where production is expected to further increase to 3,500 units and all other cost remains the same, the below will be our results:
MiniY: Production Cost | Budget April 20X8 | April Cost Per unit | May Cost Per unit | Budget May 20X8 |
Production–Units of MiniY | $3,000 |
|
| $3,500 |
Components cost (variable) | $24,000,000 | $8,000 | $8,000 | $28,000,000 |
Labor cost (variable) | $13,500,000 | $4,500 | $4,500 | $15,750,000 |
Rent (fixed) | $6,000,000 | $2,000 | $1,714 | $6,000,000 |
Depreciation (fixed) | $6,000,000 | $2,000 | $1,714 | $6,000,000 |
Other (fixed) | $2,000,000 | $667 | $571 | $2,000,000 |
Total | $51,500,000 |
|
| $57,750,000 |
Product Cost Per unit | $17,167 | $17,167 | $16,500 | $16,500 |
We can see from the above results, the cost per unit will further reduce to $16,500 per unit (4% reduction due to lower fixed cost per unit). This amount can be used to help increase the gross profit level for the organization, which will help recover other overhead costs, which are not related to production i.e. finance cost, human resources, marketing and research, legal costs and other commercial related expenses. Effectively, we can see that the more the production level increases, the more our cost per unit will further reduces in the other months i.e. from June – Dec 20x8.
...