RecommendationI recommend that proposal 2 should be chosen, because it has maximum profit. It also has the best margin of safety and contribution/sales ratio. In proposal 2, an additional product W is added to the mix.
So the fixed cost is increased. Although the fixed cost is increased, the profit increases sharply. What is noteworthy is that breakeven point is the largest in the 3 situations. It means that the company should take longer time to reach the breakeven point. So the company many have more risk.
The recommendation is made on the basis that the company has the capacity to produce all products. The company should be confident that there has enough demand for the new product W.QualificationWhen the company fully uses the production capacity, it can produce and sell all products. The company should be confident that this is possible at present and in the future.Limitation of breakeven analysis1.
Breakeven analysis can be used for the company which produce only single product.2. Breakeven analysis is valid within short period of time. Because any of the elements change.
It would lead to the change of breakeven point.3. When we use breakeven analysis, we assume that total fixed cost keep the same within the related range.
But in the fact, the output exceed the relevant range, the total fixed cost will increase.4. We assume that variable cost per unit keep the same and total variable cost can be represented as a straight line.
But in the fact, if we change the supplier, the cost of material may decrease; the variable cost per unit may change.5. We assume that selling price keep the same and total sales can be represented as a straight line. But in the fact, selling price may change. In order to increase sales, the company may reduce the selling price.
6. When we use breakeven analysis, we focus on the breakeven point. But when we make short-term decision, the company needs consider many other factors. For example, whether the company can save enough cash or we will also consider other qualitative factors.7. It is assume that total costs can be separated into fixed coat and variable cost. But in fact, it is difficult to allocate mixed costs into fixed cost and variable cost.