Gina owns G’s Clay Pots, a manufacturer of clay planting pots of all different sizes.
Gina is considering manufacturing a new product line: ceramic pots. He collects the following estimates for each ceramic pot:
Sales price per pot = $28
Direct materials cost per pot = $5
Direct labor cost per pot = $3
Variable utilities costs per pot = $2
In addition to the costs above, Gina must develop a new production line for the ceramic pots. She can rent additional machinery for $20,000 per month. The additional machinery can produce 2,000 pots per month, but the machinery rent cost is the same no matter how much of the capacity is actually used.
Finally, the ceramic pots require $10,000 in additional fixed operating costs per month.
Gina’s Analysis and Interpretation
Gina has many years of industry experience, as well as an MBA degree. She recalls learning cost-volume-profit analysis in her accounting courses, and uses this analysis to compute the break-even point for the ceramic pot line.
Her analysis is as follows:
Breakeven Point =
_____Total Fixed Costs________
Contribution Margin per Unit
Total Fixed Costs = $10,000
Contribution Margin per unit = Selling price per unit – Variable costs per unit
Selling price = $28
$5 in direct materials
$3 in direct labor
$2 in utilities
$10 in machinery rent ($20,000 per month / 2,000 pots per month)
Breakeven Point = $10,000 / ($28 – 5 – 3 – 2 – 10) = $10,000 / $8 = 1,250 pots
Gina compares her break-even point to her facility’s capacity and to her estimates of monthly demand.
Gina feels that her plan to produce and sell ceramic pots is feasible and will be profitable.
Given this finding, she runs an analysis regarding the feasibility of earning $3,000 in net income (after income taxes of 30%).
She finds that she needs 1,625 units to achieve the desired net income, and concludes that monthly capacity and demand are sufficient.
Write a critique of the analysis prepared by your client.
Specifically address the following questions:
Note: If applicable, use your “corrected” analysis for the remaining parts of the assignment.
Explain to the client how the results of the analysis should be interpreted.
Is the client’s original conclusion correct? Should it be adjusted or qualified in some manner?
Provide sufficient reasoning for your position
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