Question

Chester has negotiated a new labor contract for the next round that will affect the cost for their product Cat. Labor costs will go from $2.90 to $3.40 per unit. Assume all period and variable costs as reported on Chester's Income Statement remain the same. If Chester were to pass on half the new labor costs to their customers, how many units of product Cat would need to be sold next round to break even on the product

Answer 1

Question Completion:

Assume the following:

Selling price per unit = $54

Current total variable cost = $24.50

Total Fixed Costs = $69,000

Answer:

Chester

To break-even on product Cat, Chester needs to sell 2,379 units instead of 2,339 units.

Explanation:

a) Calculations:

New variable cost will increase by ($3.40 - $2.90)/2 = $0.25

New variable costs will be = $24.75 ($24.50 + $0.25)

Contribution margin per unit = $29.25 ($54 - $24.75)

New fixed costs = $69,000 + ($0.25 * 2,339) = $69,585

Old break-even units = $69,000/$29.50 = 2,339 units

New break-even units = Fixed cost/contribution margin per unit

= $69,585/$29.25

= 2,379 units

b) Chester's break-even point in units is calculated by using the break-even formula: Fixed Costs ÷ (Sales price per unit – Variable costs per unit) or $69,585/$29.25.  The variable cost per unit includes only the cost that will be passed to customers.  This means that half of the labor cost is regarded as variable, while the other half is taken is fixed cost.