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.