- 10 Marks
MA – L2 – Q32 – High/low analysis
Question
ZAMCO
(a) Using the high/low method, calculate the variable cost per unit and the monthly fixed costs for ZAMCO.
(b) Calculate the normal sales price per unit and the contribution per unit at this sales price.
(c) A new customer has offered to buy 25,000 units each month from ZAMCO at a price that is 20% below the normal sales price. Accepting this offer would result in a fall in other sales by one-fifth of the units sold to the new customer. Advise whether ZAMCO should accept the new customer’s offer.
Answer
(a) 100% capacity each month = 112,000 units / 0.80 = 140,000 units.
Using high/low analysis:
| Units | Total Cost (GH₵) |
|---|---|
| High: 140,000 | 695,000 |
| Low: 112,000 | 611,000 |
| Difference: 28,000 | 84,000 |
Therefore variable cost per unit = GH₵84,000 / 28,000 units = GH₵3.
Substitute in high equation:
Total cost of 140,000 units = 695,000
Variable cost of 140,000 units (× GH₵3) = 420,000
Therefore fixed costs per month = 275,000
(b) Contribution/sales ratio = 60%
Therefore variable cost/sales ratio = 40%
The normal sales price per unit = GH₵3 / 0.40 = GH₵7.50
The contribution per unit at the normal selling price is GH₵7.50 – GH₵3 = GH₵4.50 per unit.
(c) If the customer’s offer is accepted, the sales price for the 25,000 units will be GH₵7.50 – 20% = GH₵6 per unit.
The contribution per unit for these units will be GH₵6 – GH₵3 = GH₵3.
The reduction in monthly sales at the normal price will be 1/5 × 25,000 = 5,000 units.
Increase in contribution from 25,000 units sold (25,000 × GH₵3) = 75,000
Loss of contribution from fall in other sales (5,000 × GH₵4.50) = 22,500
Net increase in profit each month = 52,500
By accepting the new customer’s offer, the profit would increase by GH₵52,500 each month. The offer should therefore be accepted.
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