During a visit to Surrey, Jassa gets into conversation with the owner of a local restaurant, Maharaja Catering. The owner of Maharaja tells Jassa he is willing to sell samosas for $1.25 each to Chintu Chaiwala as long as Chintu pays for all shipping and handling costs. The shipping and handling for 100 samosas would be $50. Chintu would like to know whether it makes sense to purchase samosas from Maharaja Catering or continue making them in-house. Chintu estimates that $125 of overhead is spent producing 500 weekly servings of samosas. The other costs are typically 50% direct labour and 50% on direct materials. Chintu is wondering what the breakeven revenues and units are with regards to samosa servings. She has also heard of margin of safety and CVP graphs- she would like more details on those.
How do I solve for this? how get CVP graphs and margin of safety?
This is the only information thats why I got stuck with this
| Expenses Samosa | ||||
| Maharaja | Chintu | |||
| Price | 1.25 | Overhead | 125 | |
| unit | 100 | Unit | 500 | |
| Shipping fee | 50 | Direct labour | 50% | |
| direct Materials | 50% | |||
To determine whether Chintu Chaiwala should purchase samosas from Maharaja Catering or continue making them in-house, we need to perform a breakeven analysis. This analysis will help Chintu understand at what level of samosa servings his costs will be covered, and he will neither make a profit nor incur a loss.
First, let’s calculate Chintu’s costs for making samosas in-house.
Overhead Costs: Chintu incurs $125 in overhead costs for 500 servings of samosas. This means the overhead cost per serving is $125 / 500 = $0.25 per serving.
Direct Labor and Direct Materials: Chintu mentions that direct labor and direct materials each contribute 50% to the cost. So, for each serving, direct labor cost is $0.25 * 0.50 = $0.125, and direct materials cost is also $0.25 * 0.50 = $0.125.
Now, let’s calculate the total cost per serving when making samosas in-house:
Total Cost per Serving = Overhead Cost + Direct Labor Cost + Direct Materials Cost Total Cost per Serving = $0.25 + $0.125 + $0.125 = $0.50 per serving
Now, let’s compare this cost to what Chintu would pay Maharaja Catering for samosas:
The price offered by Maharaja is $1.25 per samosa.
Chintu needs to buy 100 samosas.
Total Cost of Purchasing 100 Samosas from Maharaja = 100 * $1.25 = $125
Now that we have both the in-house cost and the cost of purchasing from Maharaja, we can find the breakeven point.
Breakeven Revenues and Units
The breakeven point is the level of samosa servings at which Chintu’s in-house cost equals the cost of purchasing from Maharaja Catering. To find this, we can set up an equation:
In-House Cost per Serving * X (number of servings) = Cost of Purchasing from Maharaja $0.50 * X = $125
Now, solve for X:
X = $125 / $0.50 X = 250 servings
So, Chintu needs to sell 250 samosa servings to break even. This means that if he expects to sell more than 250 servings, it makes sense to continue making samosas in-house. If he anticipates selling fewer servings, purchasing from Maharaja Catering would be more cost-effective.
Margin of Safety and CVP Graphs
Margin of Safety: The margin of safety is the difference between the actual or expected sales and the breakeven point. In this case, if Chintu expects to sell 500 servings (his current production level), the margin of safety is 500 – 250 = 250 servings. This means he is operating with a margin of safety of 250 servings beyond the breakeven point.
CVP (Cost-Volume-Profit) Graphs: A CVP graph is a visual representation of how costs, revenues, and profits change with changes in the level of activity (in this case, samosa servings). In the graph, the breakeven point is where the cost and revenue lines intersect. Above the breakeven point, Chintu would be making a profit, and below it, he would incur losses. The margin of safety can also be represented on this graph as the gap between the current sales level and the breakeven point.
In conclusion, Chintu can make an informed decision about whether to purchase samosas from Maharaja Catering or continue making them in-house based on the breakeven analysis. If he expects to sell more than 250 servings, making them in-house is more cost-effective. The margin of safety and CVP graphs provide additional insights into the profitability of his samosa production.
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