The new owners are evaluating the operating structure, and you have two possible alternatives. One alternative requires a high level of investment in fixed costs compared to the other alternative. Jorge, your supervisor, has assigned you the task of evaluating the two alternatives.
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 1Alternative 2Variable costs$2.20$2.70Fixed costs$80,000$30,000Total assets$350,000$350,000
Jorge has asked you to provide detailed responses to the following questions:
- How does CVP analysis help management in the planning stage of a new business? How does CVP analysis assist the decision makers of an existing business?
- What is the break-even quantity for each of the investment alternatives, calculated using an algebraic approach? Complete the tables for each alternative using the Microsoft Excel Template given below and indicate the break-even points. Using Microsoft Excel, graph the relevant data, showing the break-even points and the profit levels for each alternative. Explain the differences between the two alternatives.
- What is the degree of operating leverage (DOL) for each alternative at 90,000 units?
- What is the significance of different DOLs using this example?
- What does the return on equity (ROE) ratio tell management? How is it used in the decision-making process?
- What is the ROE under each alternative at an output level of 124,000 for Alternative 1 and 60,000 for Alternative 2? (As the company has no debt, the formula for ROE becomes profit/assets. Use this formula.) Explain the reason for and significance of your answers.
- Which alternative would you recommend to the company? Explain the pros and cons of each alternative and the reasons for your selection.
Click here to download the Microsoft Excel Template for this week. This includes two Sheets, one for each alternative.
1 PRICE QUANTITY SOLD AVC TR TFC TVC TOTAL COST PROFIT
2 3.45 0
3 3.45 34,000
4 3.45 64,000
5 3.45 94,000
6 3.45 124,000
7 3.45 154,000
8 3.45 184, 000
9 3.45 214,000
10 3.45 244,000
11 3.45 274,000
12 3.45 304,000
1 PRICE QUANTITY SOLD TFC TR TVC TC PROFIT AVC
2 3.45 0
3 3.45 40,000
4 3.45 60,000
5 3.45 90,000
6 3.45 120,000
7 3.45 150,000
8 3.45 180,000
9 3.45 210,000
10 3.45 240,000
11 3.45 270,000
12 3.45 300,000
13 3.45 330,000
- Compile your calculations and graph in a Microsoft Excel spreadsheet
Correctly evaluated the nature and uses of CVP analysis, ROE analysis, and the consequences of different degrees of operating leverage.
Determined the break-even points for each of the alternatives graphically and algebraically.
Determined the break-even point appearing on the Template.
Explained the correct calculations and the significance of these measures for the DOL and ROE for each alternative.
Justified the best alternative for the company using the pros and cons of each alternative. Use APA