Effect of Change in Price
Management is generally confronted with a problem of analyzing the effect of changes in sales price upon the profitability of the concern. It may be required to reduce the prices on account of competition, depression, expansion, etc. The effect of changes in selling price can be easily analyzed with the help of CVP analysis.
Illustration
The following is the structure of variable cost of a toy manufactured by Toys India Ltd.
Material : Rs.150 per unit
Labor : Rs.40 per unit
Overheads : Rs.20 per unit
The selling price of the toy is Rs.300 per unit. The fixed cost for the year amounts to Rs.1,20,000 and the sales for the year is Rs.4,80,000. The coming year will see an increase in the wages of employees by 10%, material cost by 6%, variable overhead by 5% and fixed expenses by 2%. You are required to calculate the new selling price for the coming year provided the current P/V ratio is being maintained.
Solution
Let us calculate the P/V ratio first.
Rs.
|
Selling Price
|
|
Total variable cost
|
|
Material
|
|
Labour
|
|
Variable overhead
|
|
|
|
Total variable cost
|
|
|
|
Contribution per unit
|
= 300 - 210 = Rs.90
|
|
Number of units sold
|
= 4,80,000/300 = 1,600 units
|
|
Total contribution
|
= Rs.1,600 x 90 = Rs.1,44,000
|
|
Fixed cost
|
= Rs.1,20,000
|
|
Profit
|
= Rs.1,44,000 - Rs.1,20,000 = Rs.24,000.
|
|
P/V ratio
|
= Contribution per unit/Selling price per unit
|
|
|
|
Now let us compute the increase in the variable cost for the coming year.
|
Particulars
|
Current year
(Rs.)
|
Increase
(%)
|
Total
(Rs.)
|
|
Material
Labor
Overhead
|
150
40
20
|
6
10
5
|
159
44
21
|
|
Total
|
|
|
224
|
|
Fixed cost
|
1,20,000
|
2
|
1,22,400
|
New selling price for the forthcoming year,
Variable cost = (1 - P/V ratio) of selling price
224 = (1 - 0.30) of selling price
224 = 0.70 of selling price
Selling price = 224/0.70 = Rs.320
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