Question

A company is asking you to evaluate whether to start a specialty tile manufacturing unit. The initial cost of setting up the manufacturing infrastructure is estimated to be $2000,000. The cost of manufacturing each type of tile is $4 and the estimated revenue for each is $8.
A. Tell the management the number of units they must sell in the first six month to break-even between revenue and costs.
B. Should the company invest in this venture if the marketing says their forecast is for 400,000 units during the first six months?

Answer 1

Answer:

Initial cost of setting up the manufacturing infrastructure = $2,000,000

Variable manufacturing cost per tile = $4

Selling price(revenue) per tile sold = $8

Company can earn contribution of = Selling price (revenue) per tile sold - Variable manufacturing cost per tile = $8 - $4 = $4 per tile sold

Break Even point (in units) = Fixed cost / Contribution per unit of tile = $2000000/$4 = 500,000 tiles

a. The company must sell 500,000 tiles in the first six months in order to break even

b. The company should not invest in this venture as it would not even be able to cover the total cost of investment. Reason is the break-even number of tiles to be sold is more than the forecasted sales units by 100,000 (500,000 - 400,000)

Also, company would incur a loss the first six months:

= Number of tiles*Revenue per tile - Fixed Cost - Number of tiles * Variable cost per tile

= 400000*$8 - $2000000 - 400000*$4

= $3200000 - $2000000 - $1600000

= ($400,000) loss.