Question 3a
Samsung Ltd. are the manufacturers of Television. The following are the details of a Product during the year 2022.
Ordering Cost Rs.50 per order
Inventory carrying cost 10% per annum
Cost of Product A is Rs. 500 per unit
Annual consumption of Product A is 5000 units.
Compute the Economic order quantity. What if the inventory maintained by the company is 200 units?
SOLUTION:
To compute the Economic Order Quantity (EOQ), we can use the formula:
EOQ = sqrt((2 * Annual Consumption * Ordering Cost) / Inventory Carrying Cost)
Given: Ordering Cost (OC) = Rs. 50 per order Inventory Carrying Cost (ICC) = 10% per annum Cost of Product A = Rs. 500 per unit Annual Consumption of Product A = 5000 units
Plugging in the values into the formula:
EOQ = sqrt((2 * 5000 * 50) / (0.10 * 500)) EOQ = sqrt((500000) / (50)) EOQ = sqrt(10000) EOQ = 100 units
The Economic Order Quantity is 100 units.
If the inventory maintained by the company is 200 units, we can compare it with the EOQ to determine if it is above or below the EOQ.
If the inventory is 200 units, which is higher than the EOQ of 100 units, it means that the company is holding excess inventory. This excess inventory can result in higher carrying costs and tie up capital that could be used elsewhere. It is advisable for the company to consider reducing their inventory level closer to the EOQ to optimize their inventory management and reduce costs.
Question 3 (b)
New Corp Ltd. incurs fixed costs of Rs. 5,00,000 per annum. The company produces a single product with annual sales budgeted to be 70,000 units at a sales price of Rs.300 per unit. Variable costs are Rs.280 per unit. You are required to determine the breakeven point and explain the significance of breakeven point.
SOLUTION:
To determine the breakeven point for New Corp Ltd., we need to calculate the number of units the company needs to sell in order to cover its fixed costs. The breakeven point occurs when the company’s total revenue equals its total costs, resulting in neither profit nor loss.
Given information:
- Fixed costs: Rs. 5,00,000 per annum
- Sales price per unit: Rs. 300
- Variable cost per unit: Rs. 280
- Annual sales budgeted: 70,000 units
To calculate the breakeven point, we can use the following formula:
Breakeven Point (in units) = Fixed Costs / (Sales Price per unit – Variable Cost per unit)
Breakeven Point = 5,00,000 / (300 – 280) = 5,00,000 / 20 = 25,000 units
Therefore, New Corp Ltd. needs to sell 25,000 units in order to reach the breakeven point.
Significance of Breakeven Point:
- Profitability Assessment: The breakeven point provides a crucial reference point to assess the profitability of a business. Below the breakeven point, the company will incur losses, while above the breakeven point, it will generate profits.
- Decision Making: The breakeven point helps in making informed decisions regarding pricing, cost control, and production volume. By understanding the level of sales needed to cover costs, a company can determine the viability of new projects or products.
- Financial Planning: The breakeven point assists in financial planning by providing insights into the sales volume required to cover fixed costs. It helps in setting sales targets and determining the minimum revenue needed to cover expenses.
- Risk Assessment: Knowing the breakeven point allows a company to assess the risk associated with different business scenarios. By analyzing the impact of changes in sales volume, price, or costs, a company can evaluate potential risks and develop strategies to mitigate them.
- Performance Evaluation: The breakeven point serves as a benchmark for evaluating the performance of a company. By comparing actual sales and costs with the breakeven point, management can assess the efficiency and effectiveness of its operations.
In summary, the breakeven point is a vital metric that helps businesses understand their cost structure, assess profitability, make informed decisions, and evaluate performance. It provides a foundation for financial planning and risk management.