Would each of the following increase, decrease, or have an indeterminant effect on a
firm’s breakeven point (unit sales)?
a. An increase in the sales price with no change in unit costs.
b. An increase in fixed costs accompanied by a decrease in variable costs.
c. A new firm decides to use MACRS depreciation for both book and tax purposes
rather than the straight-line depreciation method.
d. Variable labor costs decline; other things are held constant.
Think it through. What do you think. Take a shot.
A new firm decides to use MACRS depreciation for both book and tax purposes rather than the straight-line depreciation method.
a. An increase in the sales price with no change in unit costs would decrease a firm's breakeven point (unit sales). To understand why, let's break down the breakeven point calculation. The breakeven point is the level of sales at which a company neither makes a profit nor incurs a loss. It is determined by dividing the total fixed costs by the contribution margin per unit (which is the difference between the sales price and the variable cost per unit).
Since there is no change in unit costs (variable costs), but there is an increase in the sales price, the contribution margin per unit will increase. As a result, the breakeven point (unit sales) will decrease because each unit sold generates more contribution margin towards covering fixed costs.
b. An increase in fixed costs accompanied by a decrease in variable costs could have an indeterminate effect on a firm's breakeven point (unit sales). In this scenario, the effect on the breakeven point depends on the magnitude of the changes in fixed costs and variable costs.
If the increase in fixed costs is greater than the decrease in variable costs, the breakeven point will increase. This is because the total costs (fixed costs + variable costs) have increased. To cover the higher total costs, more unit sales will be required to reach the breakeven point.
Conversely, if the decrease in variable costs is greater than the increase in fixed costs, the breakeven point will decrease. This is because the variable costs per unit have decreased, increasing the contribution margin per unit. As mentioned earlier, a higher contribution margin reduces the breakeven point (unit sales).
c. A new firm deciding to use MACRS depreciation for both book and tax purposes rather than the straight-line depreciation method would have an indeterminate effect on the breakeven point (unit sales). Depreciation affects the fixed costs component of the breakeven point calculation.
If the MACRS depreciation method results in lower annual depreciation expenses compared to the straight-line method, the fixed costs will be lower. This would decrease the breakeven point (unit sales) because the total fixed costs are reduced.
However, if the MACRS depreciation method results in higher annual depreciation expenses, the fixed costs will increase, leading to an increase in the breakeven point (unit sales).
d. If variable labor costs decline while other things are held constant, the breakeven point (unit sales) would decrease. Variable labor costs are a component of the unit cost, so a decline in variable labor costs would increase the contribution margin per unit. As a result, the breakeven point (unit sales) would decrease because less sales volume would be required to cover the lower unit costs.