Almo Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Almo developed its 2010 business plan based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $100,000. Almo’s after-tax profit objective was $240,000; the company’s effective tax rate is 40 percent.
While Almo’s sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the 2010 after-tax profit projection would not be reached unless some actions were taken. Almo’s president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president.
A. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year.
Total fixed and variable unit costs will stay as budgeted.
B. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast.
C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.
Required:
1. Determine the number of units that Almo Company must sell in order to break even assuming no changes are made to the selling price and cost structure.
2. Determine the number of units that Almo Company must sell in order to achieve its after-tax profit objective.
3. Determine which one of the alternatives Almo Company should select to achieve its annual after-tax profit objective. Be sure to support your selection with appropriate calculations.
4. The precision and reliability of CVP analysis are limited by several underlying assumptions. Identify at least four of these assumptions. (CMA adapted)