Ask a new question

Question

Diana has recently followed a course in furniture making and has decided to set up her own workshop from which she will be producing wooden chairs. She starts renting a small workshop at an annual rental cost of $6,000, business rates amount to $1,000 per annum, while workshop heating and lighting will cost $800 annually.

The direct cost information for one wooden chair is given below:

$

Direct materials: Wood 18

Glue 0.6

Screws 1

Sandpaper 0.4

Direct labour 25

Diana decides that her workshop is capable of producing a normal output of 1000 chairs

annually.

(a) Calculate the total product cost of one chair. (2 marks)

Based on calculations of the total product cost per unit, Diana decides to set selling price at

$85. She has just heard another entrepreneur talking about break even analysis and she

wants to apply this concept in her business.

(b) Calculate the break-even point and Margin of Safety, both in units and value, for

the business. (4

marks)

Diana's friend, who has a degree in marketing, has analysed the wooden furniture market

and has suggested that, given the high level of competition, she should reduce her market

price to $70, as a result of which sales level will increase by 50%. As the workshop has

spare capacity, fixed costs would not change and costs of labour and materials per unit are

also expected to remain unchanged at the higher production level.

(c) Find the profit/loss level arising as a result of the lower selling price and advise

Diana whether she can go for the price cut. Also, highlight the advantages and

limitations of price cuts.

(7 marks)

Diana's business is working well and she is becoming famous in the furniture making

market. She has recently received a special order for 50 dining chairs from an NGO. Given

that they are a non-profit making organization, they have informed Diana that they can only

afford $50 for each chair. Diana knows that her total product cost per unit is higher than the

proposed selling price so she is not very keen to accept the special order.

(d) Assuming that the workshop has spare capacity and no other additional costs, other than

variable costs of producing the additional chairs would be incurred, advise Diana whether

she can accept the special order. Moreover, she wants to know about the possible

drawbacks of accepting one off special orders.

(6 marks)

(e) How will your advice change if the additional order for 50 chairs implied giving up

50 chairs of current production, assuming there is no spare capacity. (3

marks)

Diana is expanding fast and has more orders than she can currently fulfill with only 2

employees. She now has annual orders for 1500 chairs at a price of $85. She is considering

whether to take a third employee. This decision will not increase her fixed costs as she has

spare capacity to accommodate another two workers. Best Woods, another furniture-maker,

has offered to make the additional 500 chairs for Diana and sell them at a cost of $49 each.

Diana is quite happy with this proposal as she knows her total product cost per unit is higher

than the proposed price.

(f) Advise Diana whether she should employ the additional worker and do the annual

production herself or buy them from Best Woods. Your answer should be supported

by both financial and non-financial reasons. (10

marks)