Pegasus Avionics makes aircraft instrumentation.Its basic navigation radio requires $80 in variable costs and $5000 per month in fixed costs.Pegasus sells 10 radios per month.If the company further processes the radio,to enhance its functionality,it will require an additional $29 per unit of variable costs,plus an increase in fixed costs of $290 per month.The current sales price of the radio is $310.The marketing manager is sure that Pegasus can charge a higher sales price for the improved version.At what sales price level would the new,improved radio begin to improve operating earnings? (Round to the nearest whole dollar.)

Question

Quizplus · Accepted Answer

The current operating earnings of Pegasus Avionics can be calculated as follows:
Revenue from 10 radios at $310 each = $3,100
Variable costs = $80 per radio x 10 = $800
Fixed costs = $5,000
Operating earnings = Revenue - Variable costs - Fixed costs = $3,100 - $800 - $5,000 = -$1,700 (negative indicates loss)

If the company further processes the radio to enhance its functionality, the new operating earnings can be calculated as follows:
Additional variable costs = $29 per radio x 10 = $290
Increased fixed costs = $5,000 + $290 = $5,290
New revenue per radio = a higher sales price than $310
New variable costs per radio = $80 + $29 = $109
New operating earnings per radio = New revenue per radio - New variable costs per radio - (Total fixed costs / Number of radios sold)
New operating earnings per radio = (New revenue per radio - $109) - ($5,290 / 10)
New operating earnings per radio = (New revenue per radio - $109) - $529
New operating earnings = 10 x (New revenue per radio - $109) - $529

To improve operating earnings, the new operating earnings should be positive. Therefore,
10 x (New revenue per radio - $109) - $529 > 0
10 x (New revenue per radio - $109) > $529
New revenue per radio - $109 > $52.90
New revenue per radio > $161.90
So the new sales price should be higher than $161.90 + $109 = $270.90.
Since the marketing manager believes Pegasus can charge a higher sales price for the improved version, the answer is A) at a sales price higher than $368. This is because the operating earnings will also have to cover the increased fixed cost of $290 per month for processing the radio further.

Pegasus Avionics Makes Aircraft Instrumentation