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Sensitivity Analysis with a Profit Target

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You are provided with the following data relating to gizmo division of Tumbledown plc.

Variable cost per unit = $320 for outputs up to 16,000 units
= $240 for extra outputs over 16,000 units

Fixed costs = $1,200,000

Sales during the last period were 16000 units @ $400 per unit

The directors are far from satisfied with the above position, and at their last board meeting set a profit target of $400,000 for the next period, and suggested that, in order to achieve this target, one of the following options be adopted:

(i) Reduce selling price by $20 per unit

(ii) Spend $100,000 on TV advertising, reducing the selling price to $360 per unit

(iii) Increase quality at a cost of $10 per unit and maintain the selling price at $400 per unit

(iv) Buy a new machine which will cut variable cost by $20 per unit, but would increase fixed cost by $72,000. The selling price would remain at $400 per unit

Required

(a) Calculate the number of gizmos required to break even under present price and cost conditions. Calculate how many units would have to be sold to meet the profit target for each of the suggested options

(b) Write a brief note for the directors discussing the implications of your findings and recommending which option they should adopt. Your report should address any other important matters which should be considered in arriving at their final decision

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Solution Summary

This solution illustrates one way to compute a break-even point when variable costs change with the level of volume.

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You will be turning in two (2) deliverables, a short write-up of the project and the spreadsheet showing your work.

Write up:

Problem introduction

Write up the LP model for the problem. Include the objective function and all constraints, including any non-negativity constraints.

Present the optimal solution, based on your work in Excel. Explain what the results mean.

Write a paragraph addressing the part of the problem pertaining to sensitivity analysis and shadow price.

Excel:

As previously noted, please set up your problem in Excel and find the solution using Solver. Clearly label the cells in your spreadsheet. You will turn in the entire spreadsheet, showing the setup of the model, and the results.

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