Case Study: BILL FRENCHJoanne Lazareto Judy Liu Evelyn Rose Lumbis Larissa Nepomuceno February 4, 2012

OUTLINECase Background Statement of the Problem Objective of the Case Question and Answer Conclusion Recommendation

CASE BACKGROUNDDuo-Products Corporation manufacturing company Bill French newly hired staff accountant for six months - doing routine types of analytical work - a business school graduate - considered by his associates to be quite capable and unusually conscientious

CASE BACKGROUNDThe company must be able at least to sell a sufficient volume of goods so that it will cover all the variable costs of producing and selling the goods. Further, it will not make a profit unless it covers the fixed costs as well. The level of operation at which total costs are just covered is the break-even volume. This should be the lower limit in all our planning. Bill French

CASE BACKGROUNDFrench's Observations: Each unit's contribution to Fixed Costs after covering Variable Costs Units to be sold to break even Variable Cost per unit Fixed Cost portion of sales price Required sales to break even Fixed Cost $2.70 1,100,000 units 62.50% of selling price 37.50% of selling price $7,920,000.00 $2,970,000

French's Conclusions (See: Exhibit 1) The firm was operating at a fair margin above break even Pre-tax profits increased rapidly as volume increased

CASE BACKGROUNDExhibit 1: Break-Even Chart Total BusinessBreak-even 15,000 Last year Sales revenue Total costs

Plant capacity Past year s operations Ave. unit selling price Total fixed costs

2 million units/year 1.5 million units $ 7.20 $ 2,970,000 $ 4.50

12,000 Thousands of Dollars

PROFITS

9,000 LOSSES 6,000 Margin of safety Fixed costs Variable costs

Ave. unit variable cost

3,000

0 400 2,000 10 20 4,000 30 800 6,000 40 1,200 8,000 50 60 10,000 70 1,600 12,000 80 90 2,000 14,000 100 # of Units (000) $ of Sales (000) % Capacity

Sales Performances in Thousands

CASE BACKGROUNDMeeting in Duo-Products Corporation:Exhibit 2: Meeting Participants Bill French Wes Davidson John Cooper Fred Williams Ray Bradshaw Arnie Winetki Anne Fraser Staff Accountant Controller Production Control Manufacturing Assistant Sales Manager General Sales Manager Administrative Assistant to the President

CASE BACKGROUNDExhibit 3: Product Class Cost Analysis Normal YearAggregate Sales at full capacity (units) Actual sales volume (units) Unit sales price Total sales revenue Variable cost per unit Total variable cost Fixed costs Profit Ratios: Variable cost to sales Unit contribution to sales Utilization of capacity 2,000,000 1,500,000 $ 7.20 10,800,000 4.50 6,750,000 2,970,000 1,080,000 0.625 0.375 75% 600,000 $ 10.00 6,000,000 7.50 4,500,000 960,000 540,000 0.75 0.25 30% 400,000 $ 9.00 3,600,000 3.75 1,500,000 1,560,000 540,000 0.42 0.58 20% 500,000 $ 2.40 1,200,000 1.50 750,000 450,000 0 0.625 0.375 25% A B C

CASE BACKGROUNDAdditional inputs from other meeting participants: John Cooper - Production Control Increase unit sales by 20% and in the process push capacity to 90%. Compute on an individual product basis to distinguish the three product type.To be reflected in the chart: Figures for each of the three (A,B,C) product types.

CASE BACKGROUNDAdditional inputs from other meeting participants: Fred Williams - Manufacturing Manufacturing got an approved additional investments increasing fixed costs by at least $60,000 a month ($ 720,000 per year). Pushing plant capacity to 90% may not be that easy because there are places (in the plant) which already reached their limits.To be reflected in the chart: Increase in fixed cost. FC= 2,970,000 + (12 x P60,000)= P3,690,000

CASE BACKGROUNDAdditional inputs from other meeting participants: Ray Bradshaw Assistant Sales Manager Big shift in product-mix: - A line is losing. We will be lucky to hold up to 2/3 of its volume next year. We expect to pick-up the 20,000 units that we lose. (Increase sales by 20,000) - B line is solid for years. No expected change. (400,000) - C . We expect 250,000 units more. (in sales)

CASE BACKGROUNDAdditional inputs from other meeting participants: Arnie Winetki - General Sales Manager On product pricingDouble the price for C with no change in cost. Reasons for increasing price for C : a. Current price is inconsistent and out-of-line (too low) considering our reputation for quality. b. If we don t increase price for C , we ll be swamped (increased demand) and we can t handle it. (500,000 units approximately of unsatisfied orders).To be reflected in the chart: Change price of C to $4.80 $2.4 x 2 = $4.80

CASE BACKGROUNDAdditional inputs from other meeting participants: Anne Fraser - Administrative Assistant to President On profit1. On Net profit after taxes.

Last year s profit is $900,000, but half ($450,000) went to taxes. $300,000 were paid to stockholders as dividends. (Approximate profit after tax was only $450,000) Assumption: Tax= 50% of Net Profit Before Tax (After dividend payments, only $150,000 was left) Target for this year: $600,000 after tax ($1,200,000 before tax) Need to increase profit after taxes by $150,000 more because of plan to give out 50% more dividends because of the anniversary year. ($450,000 dividends)

CASE BACKGROUNDAdditional inputs from other meeting participants: Anne Fraser - Administrative Assistant to President 2. On union demands. Meeting union demands meant increase in variable costs by 10% across the board. (This may eat-up on bonus dividends) Company can give to union as long as this translates to increased revenue for the Company. This will necessarily increase the Company s break-even point. The Company s profit should be treated as a fixed cost.

CASE BACKGROUNDAdditional inputs from other meeting participants: Anne Fraser - Administrative Assistant to President 3. On changing product-emphasis. Product contribution of A line is the lowest among three. Solution: Shift some assets from A to C . Wes Davidson (Controller): Bill, you rework your chart. The chart is based on a series of assumptions. Try to set those assumptions in black and white. Additional, insert in the chart the following: Unit sales increase, change in product mix, price change in C , increase in fixed manufacturing costs of $60,000 a month, taxes, dividends and product emphasis. Compute also for individual products.

STATEMENT OF THE PROBLEM What should be Bill French s revised cost-volume-profit (CVP) analysis after his colleagues provided additional information, which he must consider in his study?

OBJECTIVES OF THE CASE STUDY To apply the cost-volume-profit analysis to: determine the company s break-even point; and determine the level of operations that must be achieved, given specific business conditions.

QUESTION & ANSWER1) What are the assumptions implicit in Bill French s determination of his company s break-even point?The following are Bill French s assumptions: a. b. c. d. There is just one break-even point for the firm. The sales mix will remain constant and there will be no substantial change in product prices. The total revenue and total expenses behave in a linear manner over the relevant range. There will be no significant changes in the business/operations (e.g. sales volume will be maintained, constant dividends for the stockholders, labor union will not affect costs). The increase in capacity will be allocated to Product C since the production of this product will be increased. The production of Product A is to be decreased, but its level of fixed costs is assumed to be unchanged.

e.

QUESTION & ANSWERIn concept, the following assumptions commonly underlie CVP analysis: a. Selling price is constant. The price of a product or service will not change as volume changes.

b. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit, and the fixed element is constant in total over the entire relevant range. c. In multiproduct companies, the sales mix is constant.

d. In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold.

Reference: Managerial Accounting by Garrison/Noreen/Brewer, 13th edition

QUESTION & ANSWER2) On the basis of French s revised information, what does next year look like? a. What is the break-even point? Break-even point Unit contribution margin = Fixed expenses / Unit contribution margin = Unit selling price Variable cost per unit

QUESTION & ANSWER2) On the basis of French s revised information, what does next year look like? b. What level of operations must be achieved to pay the extra dividend, ignoring union demands? Unit sales to attain the target profit = (Target profit + Fixed expenses) Unit contribution margin Target profit Fixed expenses Unit contribution margin 1,200,000 (profit before tax)* 3,690,000 3.56

Unit sales to attain the target profit = 1,373,596 units

*

-> Net operating income x 2 -> Profit is divided almost evenly between the firm and the government -> Case given

QUESTION & ANSWER2) On the basis of French s revised information, what does next year look like? c. What level of operations must be achieved to meet the union demands, ignoring bonus dividends? Unit sales to attain the target profit = (Target profit + Fixed expenses) Unit contribution margin Target profit 900,000 (profit before tax)

Fixed expenses Unit contribution margin

-

3,690,000 3.22

Unit sales to attain the target profit = 1,423,571 units

QUESTION & ANSWER2) On the basis of French s revised information, what does next year look like? d. What level of operations must be achieved to meet both dividends and expected union requirements? Unit sales to attain the target profit = (Target profit + Fixed expenses) Unit contribution margin Target profit 1,200,000 (profit before tax)

Fixed expenses Unit contribution margin

-

3,690,000 3.22

Unit sales to attain the target profit = 1,516,615 units

QUESTION & ANSWER3) Can the break-even analysis help the company decide whether to alter the existing product emphasis? What can the company afford to invest for additional C capacity?

Yes, Break-even analysis is useful for company in deciding the product emphasisProduct C's Price Contribution Margin Total Units Fixed cost can be covered Current fixed cost Maximum Investment Profit Loss from A Max Investment if A's loss taken Old (2.4) 0.9 950,000 855,000 450,000 405,000 500,000 Not Possible New (4.8) 3.3 950,000 3,135,000 450,000 2,685,000 500,000 2,185,000

QUESTION & ANSWER4) Calculate each of the three products break-even points using the data in Exhibit 3? Why is the sum of these three volumes not equal to the 1,100,000 units aggregate break-even volume?

Product A = 384,000 units Product B = 297,143 units Product C = 500,000 units The sum total is not equal to the 1,100,000 units aggregate breakeven volume because each product has a different contribution margin ratio and different level of fixed costs and sales volume.

QUESTION & ANSWER5) Is this type of analysis of any value? For what can it be used?

Break-even analysis is a basic tool that can be used by managers to determine the level of sales that is required for the company to start earning a profit. It allows managers to see how changing sales prices and costs affect their profits. It will help understand and formulate the relationship between costs (fixed and variable), output and profit It will help to quickly observe profit levels at different output In a wide product range, the analysis helps to find out which products are performing well and which are leading to losses The technique can be used to set sales targets and/or prices to generate target profits

CONCLUSION & RECOMMENDATION xyz

END OF PRESENTATIONThank You

Questions?