Break-even Analysis

Break-even analysis attempts to determine the volume of sales necessary for a manufacturer to cover costs, or to make revenue equal costs. It is helpful in setting prices, estimating profit or loss potentials, and determining the discretionary costs that should be incurred. The general formula for calculating break-even units is:

Break-even Units = Total Fixed Cost / (Unit Selling Price Unit Variable Cost)

In PharmaSim, total fixed costs can be broken into discretionary marketing expenditures (such as sales force and advertising budget) and fixed costs for plant and overhead. The selling price is the MSRP less the volume discount, and the unit cost of goods sold and allowance expense make up the variable cost. In this assignment, you will use break-even analysis as a check against a plan to launch a new product, and to assess the impact of higher fixed costs from an increase in capacity.

The firm has an existing product with an advertising and promotion budget of $25.0 million, and projected sales of 115 million units. They are launching a new product with a budget of $20.0 million and estimated sales of 10 million units in the first year. The sales force expense of $10 million has been allocated equally between the products, with 90% of the plant overhead to the existing product and 10% to the new product. Additional values for each product are shown in the table below:

	Existing Product	New Product
MSRP	$5.39	$4.99
Volume Discount	35%	35%
Unit Cost	$1.49	$0.99
Promotion Allowance	15%	20%
Advertising & Promo.	$25.0 mill.	$20.0 mill.
Allocated Fixed Costs	$68.0 mill.	$12.0 mill.
Projected Unit Sales	115 million units	10 million units

1. In the table above, why do the fixed costs for sales force, plant, and administrative costs need to be allocated to each product? Why are advertising and promotion expenses shown separately from the allocated amount?

2. Calculate the break-even units for each product, showing the intermediate calculations for the total fixed costs, selling prices, and unit variable costs.

3. How might the results of your break-even calculation affect the marketing of the new product? What other factors besides break-even should you consider?

4. Production anticipates it will need to increase capacity to 140 million units, adding $10.0 million to annual fixed costs. If the product allocation of the plant cost is also changed to 80%/20%, what is the impact on break-even units?