[Felix The Cat]

Hi Everyone,

‘A ceramics manufacturer sold cups last year for $7.50 each. Variable costs of manufacturing were $2.25 per unit. The company needed to sell 20,000 cups to break even. Net income was $5,040. This year, the company expects the following changes: sales price per cup to be $9.00; variable manufacturing costs to increase 33.3%; fixed costs to increase 10%; and the income tax rate to remain at 40%. Sales in the coming year are expected to exceed last year’s sales by 1,000 units. How many units does the company expect to sell this year?’

My question is 1) is the net income figure pretax or aftertax? 2) explain your answer for part 1.

Thanks.
Have a great day!

FTC.

[chandler]

Net income is after tax. In case you need an illustration of how this works:
Last year:
Contribution Margin : $7.50-$2.25= $5.25 per unit
Fixed Costs= $5.25*20,000= $105,000
Gross Income= $5,040/(1-.40)= $8,400
Number of Units Sold: = (8,400/5.25)+20,000= 21,600 Units Sold

Next Year:
Contribution Margin: $9.00-$3.00= $6.00 per unit
Fixed Costs= $105,000*1.10= $115,500
Number of units Expected to Sale: 21,600 + 1,000= 22,600
Gross Income= 22,600*$6.00 per unit – 115,500= $20,100
Net Income= $20,100 *60%= $12,060

– Probably a little more info than you need, but maybe this way you can see the whole picture.

[Felix The Cat]

Thank you for the explanation Chandler.

How do you know it is after tax though?

[Mike J]

Net Income is after tax, because it is NET of expenses. Think of how an income statement is setup. You start with income from operations, net of costs to produce what you sell, this is your variable costs. That's gross profit. Next, add to that other areas of income not related to your main reason for being in business (investment or rent). Then subtract expenses that cannot be tied to specific products or services rendered. These are your fixed costs (depreciation (assuming STL not units of production), HR salary, Accounting exp, insurance, etc and then taxes).
Look at it this way…to best answer exam questions, try to understand why you need to know these topics. Here, you are performing CVP analysis because you want to maximize profit. Profit, again, is Sales minus Costs to make the product/provide services. To maximize profit you can increase your selling price. But that can be problematic because buyers might balk. It's easier to lower costs. Fixed costs are generally beyond management's ability to change. Electric Company decides what you pay (fixed). But you can decide which vendor to go with to make your product (variable).

Hope this helps. Also, I think Chandler's answer is better than mine, from a quantitative perspective. But maybe you understand things better from a qualitative perspective like I do.

[Author]

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