Incremental Analysis Quiz #1

Refer to the Daily Application about the unfinished furniture shop. [If you haven't completed that exercise, you'll need to do so before proceeding, since this quiz is a continuation of that analysis. You'll also need to look at the multiple product breakeven analysis page if you have not done so.

Assume that Charlie accepts the deal with Spencer's Furniture Shop, with prices and costs as outline in that analysis. Assume further that sales to Spencer's constitute 25% of Charlie's production; an additional 25% are sales Charlie makes himself [independent of the dealer], and the remaining 50% are sales to the regular dealer. What happens to Charlie's breakeven point under these assumptions? Answer

Charlie's breakeven point goes to a bit over 5 units. The calculations are as follows:

Now, Charlie clearly cannot sell a fraction of a chair. What effect will rounding have on the situation? [i.e., suppose he sells quantities of 3, 1, and 1, or 2, 2, and 1 or 2, 1, and 2, for the regular, private, and Spencer sales, respectively?] Click on "more" to verify your answer.

As is evident from the table below, selling combinations of 3:1:1 and 2:2:1 both work favorably, producing more than the required $520 in contribution. In fact, the contribution from alternative 2 is incrementally greater than that from alternative 1. However, alternative 3 [sales of 2:1:2] doesn't produce enough contribution to meet the breakeven point. Since the contribution from the sales to Spencer's is only $13.50/unit, Charlie would have to sell 8 more units [for a total of 10] to Spencer's in order to breakeven if he sells only 2 to the regular dealer and 1 through private sale. [520.00 - 424.5 = 95.50; 95.50/13.50 = 7.074]. Thus 7 more units to Spencer's won't quite get him over the edge. This little exercise illustrates the dramatic impact that a major change in the contribution margin can have on profitability.

Last modified: August 03, 2005