Cost-Volume-Profit Analysis for Forever Pure

by | Jun 17, 2024 | Accounting

 

Forever Pure produces two types of water filters. One attaches to the faucet and cleans all water that passes through the faucet. The other is a pitcher-cum-filter that only purifies water meant for drinking.
The unit that attaches to the faucet is sold for $72 and has variable costs of $20.
The pitcher-cum-filter sells for $88 and has variable costs of $16.
Forever Pure sells two faucet models for every three pitchers sold. Fixed costs equal $960,000.
What is the break-even point in unit sales and dollars for each type of filter at the current sales mix?
Forever Pure is considering buying new production equipment. The new equipment will increase fixed cost by $166,400 per year and will decrease the variable cost of the faucet and the pitcher units by $4 and $8, respectively.
Assuming the same sales mix, how many of each type of filter does Forever Pure need to sell to break even?
Assuming the same sales mix, at what total sales level would Forever Pure be indifferent between using the old equipment and buying the new production equipment?
If total sales are expected to be 23,000 units, should Forever Pure buy the new production equipment?
Assess lessons learned concerning cost-volume-profit analysis and decision making.

 

Sample Answer

Sample Answer

 

Cost-Volume-Profit Analysis for Forever Pure

Break-Even Analysis at Current Sales Mix

Faucet Filter:

– Selling Price: $72
– Variable Cost: $20
– Contribution Margin per Unit: $72 – $20 = $52

Pitcher-Cum-Filter:

– Selling Price: $88
– Variable Cost: $16
– Contribution Margin per Unit: $88 – $16 = $72

Sales Mix:

– 2 faucet filters for every 3 pitcher-cum-filters

Given that fixed costs are $960,000, the contribution margin ratio for the current sales mix is calculated as follows:
Contribution Margin Ratio = (Contribution Margin per Unit * Units Sold) / Total Sales

Let x be the number of pitcher-cum-filters sold. Then, the number of faucet filters sold will be (2/3)x.

Using the contribution margin ratio formula and the sales mix ratio, we can calculate the break-even point in dollars and units for each type of filter.

Break-Even Analysis with New Production Equipment

With the new production equipment:

– Fixed Cost Increase: $166,400
– Variable Cost Reduction for Faucet Filter: $4
– Variable Cost Reduction for Pitcher-Cum-Filter: $8

The contribution margin per unit for each filter type will change based on the new variable costs. Using the updated contribution margin per unit and the increased fixed costs, we can determine the new break-even point in units for each type of filter.

Comparison between Old and New Production Equipment

To determine the total sales level at which Forever Pure would be indifferent between using the old equipment and buying the new production equipment, we need to calculate the total contribution margin for both scenarios and find the point where they are equal.

Decision on Buying New Production Equipment

Considering total expected sales of 23,000 units, Forever Pure should compare the total contribution margin under both scenarios (old equipment and new equipment) to decide whether buying the new production equipment is financially viable.

Lessons Learned on Cost-Volume-Profit Analysis and Decision Making

Through this analysis, Forever Pure can gain insights into its cost structure, pricing strategies, and break-even points for different product lines. Cost-volume-profit analysis helps in understanding the relationships between costs, sales volume, and profitability. By evaluating different scenarios and considering factors such as fixed costs, variable costs, selling prices, and sales mix, companies can make informed decisions regarding pricing, production levels, and investments in new equipment. This exercise highlights the importance of conducting thorough cost-volume-profit analysis to optimize financial performance and strategic decision-making in a competitive market environment.

 

 

 

 

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