Calculate and interpret break-even output, contribution and margin of safety to support decisions in IB Business Management SL.
In 2022, AH’s costs increased, but it kept prices unchanged. For 2023, AH decided to change its pricing strategy and pass on all cost increases to customers.
Table 2: Selected financial information for AH for 2022 and forecasted financial information for 2023
Alfombras Horizonte (AH)
Alfombras Horizonte (AH) produces natural henequen* rugs in Yucatán, Mexico, and sells them online. AH rugs are very popular among young people because of their eco-friendly materials and AH's mission statement: "We are responsible with Mother Earth for our environment and ourselves."
In 2022, AH's costs increased, but it kept prices unchanged. For 2023, AH decided to change its pricing
strategy and pass on all cost increases to customers.
Table 2: Selected financial information for \(\boldsymbol{A
* henequen: a fibre plant from Mexico and Guatemala. Fabrics made from henequen fibre are used to make a wide variety of products, including bags, rugs and hammocks.
Using relevant information from Table 2, calculate:
the break-even quantity of rugs in 2022 (show all your working);
the profit or loss for A H if 500 rugs were sold in 2022 (show all your working);
the margin of safety in 2023 if AH sells 750 rugs (show all your working).
Explain whether A H's change in pricing strategy for 2023 will have an impact on its unit contribution.
The sportswear manufacturing industry is becoming more competitive. Some foreign manufacturers have begun using penetration pricing to gain market share. For three years, none of HA’s revenue streams have increased, despite increasing unit sales. HA’s gross and net profit margins have declined. However, its sales have increased for the last three years. HA has had to raise additional external finance to increase production.
Hums Athletics (HA) manufactures running shorts, sweat shirts, and sports bras. Operating only in the secondary sector, HA has a head office and three manufacturing facilities, one for each product. These are located in its home country in Europe. Labour costs are high. The quality of labour is excellent. HA produces goods under its own HA brand, which it sells to wholesalers. HA also manufactures for other sportswear companies. HA puts the other sportswear companies’ logos on the running shorts, sweat shirts, and sports bras. Sales to other sportswear companies are an important revenue stream for HA. HA has many levels of hierarchy. Managers at each level have a narrow span of control, and the company is organized by product. HA’s management believe that these features of organizational structure ensure product quality, which they view as essential for brand loyalty.
Hums Athletics (HA)
Hums Athletics (HA) manufactures running shorts, sweat shirts, and sports bras. Operating only in the secondary sector, HA has a head office and three manufacturing facilities, one for each product. These are located in its home country in Europe. Labour costs are high. The quality of labour is excellent.
HA produces goods under its own HA brand, which it sells to wholesalers. HA also manufactures for other sportswear companies. HA puts the other sportswear companies' logos on the running shorts, sweat shirts, and sports bras. Sales to other sportswear companies are an important revenue stream for HA.
HA has many levels of hierarchy. Managers at each level have a narrow span of control, and the company is organized by product. HA's management believe that these features of organizational structure ensure product quality, which they view as essential for brand loyalty.
The sportswear manufacturing industry is becoming more competitive. Some foreign manufacturers have begun using penetration pricing to gain market share. For three years, none of HA's revenue streams have increased, despite increasing unit sales. HA's gross and net profit margins have declined. However, its sales have increased for the last three years. HA has had to raise additional external finance to increase production.
In response to the increasing competition, HA is considering two options:
- Option 1: Outsourcing some of its manufacturing overseas.
- Option 2: Entering the rapidly growing online business-to-consumer (B2C) retail market.
Market research has shown that consumers increasingly expect to buy online.
Explain:
the impact of price changes by foreign competition on H A 's break-even point;
As a result, Pablo set up Pablo’s Peanuts (PP) as a private limited company. He then purchased a food truck (a large vehicle equipped to cook and sell food). From Tuesday to Sunday, he drove to different Latin American markets in the Miami area to cook and sell his product. PP soon became profitable, but meeting demand was difficult. Pablo wants PP to grow. To do this, he needs a second food truck and an employee. The second truck would require an investment of $100 000. Pablo’s break-even analysis shows that the expected increased output would more than double PP’s profits if the cost of fuel for the food trucks remains constant.
Option 1: A local Miami bank, clearly impressed by the break-even analysis data, is willing to lend Pablo $100 000 with a 10 % interest rate.
Pablo recently emigrated from Argentina to Miami, Florida, which has a large Hispanic* population. However, he could not find caramelized peanuts – known as garrapiñada –at any of the Latin American markets in Miami. These tasty sweet snacks, sold by street vendors, are very popular in Latin American countries. Pablo began testing different recipes to make the snack himself. Once convinced he had the perfect product, he conducted primary market research in several Hispanic neighbourhoods. He was overwhelmed by the positive response.
Pablo's Peanuts (PP)
Pablo recently emigrated from Argentina to Miami, Florida, which has a large Hispanic* population. However, he could not find caramelized peanuts - known as garrapiñada -at any of the Latin American markets in Miami. These tasty sweet snacks, sold by street vendors, are very popular in Latin American countries. Pablo began testing different recipes to make the snack himself. Once convinced he had the perfect product, he conducted primary market research in several Hispanic neighbourhoods. He was overwhelmed by the positive response.
As a result, Pablo set up Pablo's Peanuts (PP) as a private limited company. He then purchased a food truck (a large vehicle equipped to cook and sell food). From Tuesday to Sunday, he drove to different Latin American markets in the Miami area to cook and sell his product. PP soon became profitable, but meeting demand was difficult.
Pablo wants PP to grow. To do this, he needs a second food truck and an employee. The second truck would require an investment of . Pablo's break-even analysis shows that the expected increased output would more than double PP's profits if the cost of fuel for the food trucks remains constant.
Pablo is considering two options to finance the second truck:
- Option 1: A local Miami bank, clearly impressed by the break-even analysis data, is willing to lend Pablo with a 10 % interest rate.
- Option 2: A business angel, Ana Perez, with a strong portfolio of Latin American food products, has approached Pablo. She is offering for 35 % of shares in PP.
Table 4: Financial data related to both options
* Hispanic: relating to Spain or to Spanish-speaking countries, especially those of Central and South America
Explain one advantage and one disadvantage of using a break-even analysis for P P.
In 2022, AH’s costs increased, but it kept prices unchanged. For 2023, AH decided to change its pricing strategy and pass on all cost increases to customers.
Table 2: Selected financial information for AH for 2022 and forecasted financial information for 2023
Alfombras Horizonte (AH)
Alfombras Horizonte (AH) produces natural henequen* rugs in Yucatán, Mexico, and sells them online. AH rugs are very popular among young people because of their eco-friendly materials and AH's mission statement: "We are responsible with Mother Earth for our environment and ourselves."
In 2022, AH's costs increased, but it kept prices unchanged. For 2023, AH decided to change its pricing
strategy and pass on all cost increases to customers.
Table 2: Selected financial information for \(\boldsymbol{A
* henequen: a fibre plant from Mexico and Guatemala. Fabrics made from henequen fibre are used to make a wide variety of products, including bags, rugs and hammocks.
Explain whether A H's change in pricing strategy for 2023 will have an impact on its unit contribution.