Assume That The Company Has No Debt Regardless Of The ✓ Solved

Assume that the company has no debt. Regardless of the

Assume that the company has no debt. Regardless of the alternative selected, market conditions will require the selling price of the product to be $3.45 per unit. The details for each alternative are given in the table.

Alternative 1:

  • Variable costs: $2.20
  • Fixed costs: $80,000
  • Total assets: $350,000

Alternative 2:

  • Variable costs: $2.70
  • Fixed costs: $30,000
  • Total assets: $350,000

Paper For Above Instructions

In evaluating the two alternatives provided for a company with no debt, we need to calculate their respective profitability based on the given selling price, variable costs, and fixed costs. The company has a selling price of $3.45 per unit, which will be applicable for both alternatives. The analysis will focus on identifying which alternative yields better financial performance, considering both variable and fixed costs.

The first step is to determine the contribution margin for each alternative. The contribution margin is computed as the selling price minus variable costs. For Alternative 1, the contribution margin is:

Contribution Margin (Alternative 1) = Selling Price - Variable Costs

Contribution Margin (Alternative 1) = $3.45 - $2.20 = $1.25 per unit

For Alternative 2, the calculation is as follows:

Contribution Margin (Alternative 2) = Selling Price - Variable Costs

Contribution Margin (Alternative 2) = $3.45 - $2.70 = $0.75 per unit

Next, we must determine the break-even point for each alternative. The break-even point indicates the number of units that need to be sold to cover total costs (both fixed and variable). The break-even point is calculated using the formula:

Break-even Point (in units) = Fixed Costs / Contribution Margin

For Alternative 1, the break-even point is:

Break-even Point (Alternative 1) = Fixed Costs / Contribution Margin

Break-even Point (Alternative 1) = $80,000 / $1.25 = 64,000 units

For Alternative 2, the break-even point is:

Break-even Point (Alternative 2) = Fixed Costs / Contribution Margin

Break-even Point (Alternative 2) = $30,000 / $0.75 = 40,000 units

Now that we have calculated the break-even points, we can analyze the profitability of each alternative based on hypothetical unit sales. Suppose we predict selling 100,000 units for the analysis. The total profit for each alternative can be determined through the formula:

Total Profit = (Contribution Margin x Units Sold) - Fixed Costs

For Alternative 1, the total profit would be:

Total Profit (Alternative 1) = ($1.25 x 100,000) - $80,000

Total Profit (Alternative 1) = $125,000 - $80,000 = $45,000

For Alternative 2, the total profit would be:

Total Profit (Alternative 2) = ($0.75 x 100,000) - $30,000

Total Profit (Alternative 2) = $75,000 - $30,000 = $45,000

From the analysis, both alternatives yield the same total profit of $45,000 at the sales level of 100,000 units. However, when considering the break-even points, Alternative 2 requires fewer sales (40,000 units) to break even compared to Alternative 1 (64,000 units). This lower break-even point may indicate that Alternative 2 could be less risky, as it requires a smaller volume of sales to avoid losses.

Moreover, with Alternative 2 having higher variable costs but significantly lower fixed costs, it is more flexible in terms of financial risk. Businesses often prefer alternatives that minimize fixed costs to reduce the financial burden during periods of lower sales.

In conclusion, both Alternative 1 and Alternative 2 lead to the same profit at a particular sales volume. Nevertheless, the choice between them can lean towards Alternative 2 due to its lower break-even requirement and lower profit risk in adverse market conditions. When making final decisions, management should also consider market trends, sales forecasts, and overall business strategy in addition to this financial analysis.

References

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