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 this more appropriate formula to calculate the breakeven sales level 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.