Question 2 (a)
Flexible budget: operating profit at 60%, 70% and 80% at the current and the proposed price
12 marks
- Time to write
- About 24 minutes
Question
Question 2 (a) · 12 marksArya Steel Ltd. makes a single product for which there exist market demand for additional quantity. Its Present Sales of Rs. 54,000 per month use only 60% of the Plant's capacity. The Marketing Manager assures that with a 10% reduction in the price he would be able to raise the sale by about 25% to 30%. (12)
The data available are:
| (i) Selling Price | Rs. 10 per unit |
|---|---|
| (ii) Variable cost | Rs. 4 per unit |
| (iii) Semi- Variable cost | Rs. 5,700 (Fixed + 50 paise per unit) |
| (iv) Fixed cost | Rs. 18,000 @ present level estimated to be Rs. 20,400 at 80% output |
You are required to prepare these statements:
At the current selling price, the Operating Profits at the 60%, 70% and 80% levels, and
At the proposed selling price, the Operating Profits at the same levels.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
What the paper leaves open
The fixed cost is stated for the present (60%) level and for 80% output; at 70% it is read as unchanged from the present level.
Write it in this order
- Read the data; note exactly what is asked 2 min
- 1 Workings capacity, semi-variable split 2 marks 3 min
- 2 Statement at the current price 5 marks 8 min
- 3 Statement at the proposed price 4 marks 7 min
- 4 Comment 1 mark 2 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 24 minutes for 12 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Working: output at each level and the semi-variable cost
- Present sales of ₹54,000 at ₹10 a unit = 5,400 units, which is 60% of capacity. Full capacity = 5,400 ÷ 60% = 9,000 units; 70% = 6,300 units; 80% = 7,200 units.
- Semi-variable cost at the present level is ₹5,700, of which the variable part is 5,400 units × ₹0.50 = ₹2,700, so its fixed part is ₹5,700 − ₹2,700 = ₹3,000 at every level.
- Fixed cost is ₹18,000 at the present (60%) level and ₹20,400 at 80%; at 70% it is taken as ₹18,000, since the rise is stated only for 80% output (paper note).
- Proposed selling price = ₹10 less 10% = ₹9 a unit.
(i) Operating profit at the current selling price (₹10)
| Particulars | 60% | 70% | 80% |
|---|---|---|---|
| Output and sales (units) | 5,400 | 6,300 | 7,200 |
| Sales (A) | 54,000 | 63,000 | 72,000 |
| Variable cost at ₹4 a unit | 21,600 | 25,200 | 28,800 |
| Semi-variable cost: fixed part | 3,000 | 3,000 | 3,000 |
| Semi-variable cost: variable part at ₹0.50 a unit | 2,700 | 3,150 | 3,600 |
| Fixed cost | 18,000 | 18,000 | 20,400 |
| Total cost (B) | 45,300 | 49,350 | 55,800 |
| Operating profit (A − B) | 8,700 | 13,650 | 16,200 |
(ii) Operating profit at the proposed selling price (₹9)
| Particulars | 60% | 70% | 80% |
|---|---|---|---|
| Output and sales (units) | 5,400 | 6,300 | 7,200 |
| Sales at ₹9 a unit (A) | 48,600 | 56,700 | 64,800 |
| Total cost, as in (i) (B) | 45,300 | 49,350 | 55,800 |
| Operating profit (A − B) | 3,300 | 7,350 | 9,000 |
The present profit is ₹8,700 (60% capacity at ₹10). A sales rise of 25% to 30% takes output from 5,400 units to 6,750–7,020 units, 75% to 78% of capacity. The paper note fixes ₹18,000 only up to 70%; the question gives no fixed cost between 70% and 80%. Taking the fixed cost to stay at ₹18,000 below 80% output (our assumption, extending the paper note's reading), at ₹9 a unit:
| Particulars | 25% rise | 30% rise |
|---|---|---|
| Output and sales (units) | 6,750 | 7,020 |
| Sales at ₹9 a unit (A) | 60,750 | 63,180 |
| Variable cost at ₹4 a unit | 27,000 | 28,080 |
| Semi-variable cost: fixed part | 3,000 | 3,000 |
| Semi-variable cost: variable part at ₹0.50 a unit | 3,375 | 3,510 |
| Fixed cost | 18,000 | 18,000 |
| Total cost (B) | 51,375 | 52,590 |
| Operating profit (A − B) | 9,375 | 10,590 |
On that assumption, at the increase the Marketing Manager expects, the price cut lifts profit above the present ₹8,700, by ₹675 to ₹1,890; whether it pays therefore turns on where between 70% and 80% the fixed cost rises.
The other reading. If the fixed cost had already risen to ₹20,400 once output passed 70%, the profit would be ₹6,975 and ₹8,190, below the present ₹8,700, and the cut would pay only at about 80% of capacity.
Where the 12 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Workings (capacity, semi-variable split) | 2 |
| 2 | Statement at the current price | 5 |
| 3 | Statement at the proposed price | 4 |
| 4 | Comment | 1 |
| Total | 12 |
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