EXERCISES:
1. A manufacturer has been selling 50,000 units per year of a certain product. The price of
this product is $20 and the variable costs associated with the product are $12 per unit. The
manufacturer is considering decreasing the price of his product to $17 so as to increase
sales. If he goes ahead with this price change, the manager will purchase new production
machinery, at a cost of $75,000, to accommodate the increased sales.
a. The manager intends to evaluate the prospective price change by computing a
breakeven sales level using the traditional formula, BE = ∆FC/CM. Explain what
is wrong with the logic of doing this.
b. Suggest a more appropriate formula for calculating a breakeven sales level. Justify
your suggestion.
c. Use more appropriate formula to calculate the breakeven sales for this prospective
price change. How can the manager use this breakeven in his decision about
whether or not to go ahead with the price change?
d. Use breakeven analysis to help the manager decide whether or not to purchase the
new production machinery while keeping the product’s price at $20.
2. Eastern Semiconductor is currently selling its most popular microchip for $220. It has been
selling 4,000 of these chips per month. The company has learned, however, that next month
an overseas competitor will enter the market and start selling a copy of this chip for $200.
If Eastern maintains its price of $220 per chip, it expects its sales to decrease to 3,000 units
per month.
a. Given that Eastern’s variable costs for this product are $40 per chip, what is the
breakeven sales level for Eastern decreasing its price by $20 price per chip?
b. Do you think it is likely that Eastern will achieve this breakeven sales level?
3. Plasiderm, Inc., sells a medical product. The company is currently selling the product for
$18/unit and is considering whether it could increase profits by increasing the product’s
price to $20/unit. Plasiderm currently sells 50,000 units per week. Its current weekly
operating data are as follows:
Sales Revenue $900,000
Variable Costs $400,000
Fixed Costs $250,000
Pretax profit $250,000
You can assume that per-unit variable costs do not vary wit hthe level of production.
a. What is the breakeven sales level for the price increase that Plasiderm is
considering? Explain what this breakeven sales level means.
b. If the sales level for this product decreased by 5,000 units per week after the price
increase, what would be the change in Plasiderm’s weekly pretax profits caused by
the price increase?
c. What would be the Plasiderm’s profit change if, after the price increase, sales
remained at 50,000 units per week?
4. A heating oil retailer has been buying heating oil at $2.82 per gallon and keeps a 30-day
supply on hand. He sells 5,000 gallons per day and has been charging his customers $3.25
per gallon. The retailer has nonincremental fixed costs of $800 per day. Yesterday the
wholesale price of heating oil decreased from $2.82 per gallon to $2.68 cents per gallon.
a. What is the per-gallon cost that is relevant for pricing decisions concerning heating
oil that the retailer will sell today? Explain your answer
b. If the heating oil retailer is planning to respond to the wholesale price decrease by
lowering his $3.25-per gallon retail price, should he wait 30 days to make the price
change? Explain your answer.
5. A leather goods retailer has been buying a popular style of handbag for $12 per bag and
selling then for $20 per bag. The retailer has been selling 200 handbags per month. The
retailer has been close to bankruptcy for the past year. In response to this threat, the
retailer’s buyer has found an overseas source for this handbag. The new source results un
the cost per handbag decreasing to $10, and the new shipments will begin arriving on
January 1. The shop’s owner feels that the arrival of the new versions of the popular
handbag might present a good occasion to carry out a $2 price increase.
a. What is the change in the retailer’s variable costs that will occur on January 1? Is
this change independent of the price change that the shop’s owner is considering or
is it tied to this prospective price change? Explain.
b. Calculate the breakeven sales level for the price increase that the shop’s owner is
considering, and justify your answer.
6. A pharmaceutical company has been selling the prescription allergy drug Aquanox to retail
pharmacists at a price of $3.20 per tablet, considerably above the company’s variable costs
of $0.52 per tablet. The company’s director of marketing has recently suggested that they
consider lowering the price, but the VP of the division rejected this idea. The VP’s
explanation was that they should not even consider lowering the price until the drug’s high
research and development costs have been recovered. Do you agree with the VP’s
reasoning? Why or why not?
7. One year ago, a manufacturer paid $3,000 for a stamping press that can produce only a
particular plastic specialty product. The press now has a market value of $2,500 and is
expected to continue to lose $500 of its market value each year. If the press were sold,
assume that the manufacturer would earn 5 percent annual interest on the proceeds of the
sale. The manufacturer is now considering changing this plastic specialty product’s price
for the coming year. If the manufacturer’s pricing decision will affect whether or not this
stamping press is retained by the company, what cost associated with the stamping press is
relevant to this decision? Explain your answer.
