# Type BEP by alicejenny

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   Unit contribution, margin and markup
   Fixed vs. variable costs
   Problems with cost-plus pricing (e.g., Death Spiral).
Team Assignment

   Project

   Mini-Presentation
Problems with Cost-plus Pricing

   Cost-plus pricing will lead to over-pricing in a weak
market.
   Cost-plus pricing will lead to under-pricing in a strong
market.
Mini Case Study: Self-Expedited “Death
Spiral”

Year   # Stores

1985      1
   In 2007 Movie Gallery changed the 7-day
1987      5
rental period to 5-day.
1992     37
   The 7-day option was retained, at an
1996     850
1999     950
   In the same year Movie Gallery filed for
bankruptcy protection and stocks dropped
2003     2000
below \$1.
2005     4700
What Could Have MG Done?

       Channel strategy

    Pricing strategy
Pricing Based on Markup / Margin
A retailer buys a sofa for \$1000. What will be the retailer’s selling price
if it decides to go with (a) 30% markup and (b) 30% margin?

   Markup
    The \$ markup is \$1000*30%=\$300
    Selling price = \$1000 + \$300 = \$1300

   Margin
    Selling price = p, say.
    The unit contribution is p*30/100
    p = 1000 + 0.3*p, so p=\$1428

7
Chapter 9

Financial Analysis
Types of BEP

Type I: BEP of              Type II: BEP of
a price change              a fixed-cost
investment

BEP Analysis

Type III: BEP of                  Type IV: BEP of
the change in                     Cannibalization
variable cost
Types of BEP

Type I: BEP of              Type II: BEP of
a price change              a fixed-cost
investment

BEP Analysis

Type III: BEP of                  Type IV: BEP of
the change in                     Cannibalization
variable cost
The cost question in pricing is not:
   What prices do we need to cover costs and
achieve our profit objectives?
The cost questions in pricing are:
   How much sales gain would be required to profit from
a price cut?
   How much sales loss would be tolerable to profit from
a price increase?
   What costs can we afford to incur and still earn a
profit?
Example: Type I BEP

PortaShelf is considering either raising or lowering their current
price by 20%.The company would like to know how many units
would have to be sold under these price changes to maintain
the current profit margin of 10%.

Current Price    Option 1        Option 2
PortaShelf       \$100             \$80             \$120
Example: Type I BEP
Option 1 – Decrease price by 20% to \$80

Price = \$80
Variable unit cost (marginal cost) = \$60
Markup = \$80 - \$60 = \$20

Therefore, each unit sold currently contributes \$20 to fixed cost recovery
and profit.

Say that fixed costs (plant, administration) are \$30 million.

Thus, twice as many units must be produced to maintain the same profit level.

Profit = [2 million units x \$80] – [(2 million units x \$60) + \$30 million]
(total revenue)          (variable cost)          (fixed cost)

= \$10 million
Example: Type I BEP
Option 1

A 20% reduction in price reduces the unit contribution by 50%
and requires that unit sales double to achieve the current
level of profitability.

Questions       – Does PortaShelf have the operating capacity to double
capacity?

If the answer is no, then both variable unit costs and fixed costs will likely
increase as PortaShelf:
Example: Type I BEP
Option 2 – Increase price by 20% to \$120
Price = \$120
Variable unit cost (marginal cost) = \$60
Markup = \$120 - \$60 = \$60

Therefore, each unit sold currently contributes \$60 to fixed cost recovery
and profit.

Say that fixed costs (plant, administration) are \$30 million.

Thus, production can be reduced by about 33% in order to maintain the
current profit level.

Profit = [667,000 units x \$120] – [(667,000 units x \$60) + \$30 million]
(total revenue)         (variable cost)             (fixed cost)
= \$10 million
Example: Type I BEP
Option 2

A 20% increase in price increases the markup by 33%
and requires that unit sales be only 2/3rds the current amount to
maintain the current level of profitability.

Depending on the organization of their operations, PortaShelf may not
require various cost items that contribute to either their variable or fixed
costs. For example, they may be able to:
How to get the percentage of need sales
volume

    Price increase by x%

       Price decrease by x%
Types of BEP

Type I: BEP of              Type II: BEP of
a price change              a fixed-cost
investment

BEP Analysis

Type III: BEP of                  Type IV: BEP of
the change in                     Cannibalization
variable cost
Total, Variable, and Fixed Costs
Type II BEP analysis chart for a picture
frame store
Formulas for Type II BEP Analysis

In Units:
Total Fixed Cost
Break-Even Point =
Contribution Per Unit to Fixed Cost

In Dollars:                  Total Fixed Cost
Break-Even Point =                   Cost
1 -Variable Price Per Unit
Formulas for Type II BEP Analysis

In Units:
Total Fixed Cost
Break-Even Point =   Unit Price – Unit Variable Price
Practice

Example: Type II BEP in Units

   Leeds Manufacturing sells bookcases for \$100 each. They
have variable costs of \$50. They want to build a new
production line with total fixed cost (TFC)of \$200,000.
What will be the break-even point(BEP) in units to cover
this new line?

 BEP = TFC / (Unit Price – Unit Variable Cost)
Practice

Example: Type II BEP in dollars?
   Sun Manufacturing sells bookcases at a price of \$100 a
piece.
   Variable costs per unit are \$50.
   They want to build a new production line with a fixed cost
of \$200,000. What will be the break-even point (BEP) in
\$\$\$ to cover this new line?
Formula for Type II BEP Analysis

In Dollars:              Total Fixed Cost
Break-Even Point =   1-   Variable Cost Per Unit
Price
Example: Type II BEP in Dollars

Total Fixed Cost
BEP (\$) =
1 - Variable Cost per unit /Price

\$200,000
=
1 - .5

=             \$400,000
Practice

Example: Type II BEP in Dollars
   Leeds Manufacturing sells bookcases. They want to
build a new production line which will cost \$200,000
and produce 4,000 new bookcases per year. If
variable cost per unit is \$50 dollars, and demand is
virtually unlimited, how much must they charge for
each bookcase if they want to breakeven in the first
year?
Practice

Example: Type II BEP in dollars

   Sun Manufacturing sells bookcases at a price of
\$100 a piece.
   Variable costs per unit are \$50.
   They want to build a new production line with a fixed
cost of \$200,000. What will be the break-even point
(BEP) in \$\$\$ to cover this new line?
Types of BEP

Type I: BEP of              Type II: BEP of
a price change              a fixed-cost
investment

BEP Analysis

Type III: BEP of                  Type IV: BEP of
the change in                     Cannibalization
variable cost
Example: Type III BEP

 Sun Manufacturing sells bookcases at a price of \$100 a
piece.
 Variable costs per unit are \$50.

 Suppose that the unit variable costs have changed to \$60,
what will be the percentage increase in sales volume in
order to make the profit remains the same?
Formula for Type III BEP Analysis

Break-Even Point = ( Unit Contribution_oldVC ) -1
Unit Contribution_newVC
Solution

   Margin at the old unit variable cost is \$50
   Margin at the new unit variable cost is \$40

50
BEP =              -1= 25%
40

   To make sure the profit remains the same, the sales
volume has to go up by 25%.
Types of BEP

Type I: BEP of              Type II: BEP of
a price change              a fixed-cost
investment

BEP Analysis

Type III: BEP of                  Type IV: BEP of
the change in                     Cannibalization
variable cost
Example: Type IV BEP

 Sun Manufacturing sells bookcases at a price of \$100 a
piece.
 Variable costs per unit are \$50.

 Suppose that the company is considering introduce a new
brand that sells \$120 and costs \$60 each, what will be the
percentage of sales for the new brand that is coming from
the existing brand, so that the profit remains the same?
Formula for Type IV BEP Analysis

Break-Even Rate = ( Unit Contribution_new offering   )
Unit Contribution_old offering
Solution
   Margin of the existing product is \$50
   Margin of the new product is \$60

50
BEP =      60
= 83.3%
   To make sure the profit remains the same, the new
product can take up to 83.3% of the market share from
the existing product.
Next Lecture

• Price Levels

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