Eaton Tool Company has fixed costs of 302600 sells its units

Eaton Tool Company has fixed costs of $302,600, sells its units for $74, and has variable costs of $40 per unit.

a. Compute the break-even point.

b. Ms. Eaton comes up with a new plan to cut fixed costs to $240,000. However, more labor will now be required, which will increase variable costs per unit to $43. The sales price will remain at $74. What is the new break-even point? (Round your answer to the nearest whole number.)

c. Under the new plan, what is likely to happen to profitability at very high volume levels (compared to the old plan)?

Solution

Answer to Part a)

Break-even point = Fixed cost/ Contribution per unit

Contribution per unit = selling price per unit – variable cost per unit
Contribution per unit = $74 - $40 = $34

Break-even point = 302,600/ 34
Break-even point = 8,900 units

Answer to Part b)

New Contribution Margin per unit = $74 - $43 = $31
New Fixed Cost = $240,000
New Break-even point = 240,000/ 31

New Break-even point = 7,742 units

Answer to Part c)

Contribution margin ratio = (Contribution/ sales) x 100

Old Plan:
Contribution margin ratio = (34/ 74) x 100

= 45.95%

New Plan:
Contribution margin ratio = (31/74) x 100
= 41.89%

The profitability at very high volume levels of Sale will not be as good as it was under old plan. Under the old plan the contribution margin ratio is around 45.95% after the break-even level is crossed, the profit   realised would be at the rate of 45.95% of sales. Whereas under the new plan the profit realised would be only 41.89%.

Thus when the sales volumes are high the profitability under the old plan would be better than the new plan.