Cost-volume-profit analysis showed how much Auto, Inc. had to improve just to break even in Year 1. In that year, the break-even point was 2.2 million units, but the company was selling considerably fewer than 2 million units. Faced with a severe recession in the industry, Auto, Inc. had virtually no chance to increase sales enough to break even. Meanwhile, the company had received loan guarantees from the U.S. government, which evoked considerable criticism that the federal government was supporting a ‘‘failing’’ company.
By Year 4, Auto, Inc. reduced its break-even point to 1.1 million units, and the company reported a profit for the first time in several years. The turnaround came despite continued low sales in the industry; it resulted primarily from severe cost cutting, which reduced fixed costs in constant dollars from $4.5 billion in Year 1 to $3.1 billion in Year 4. In addition, the company made improvements in its production methods, which enabled it to maintain its volume of output despite the reduction in fixed costs.
a. If Auto, Inc.’s break-even volume was 1.1 million units and its fixed costs were $3.1 billion, what was its average contribution margin per unit?
b. Why do you think management concentrated on reducing fixed costs to put Auto, Inc. above its break-even point?
c. As a shareholder of Auto, Inc., what concerns might you have about the company’s massive cost cutting?