Elephant Books sells paperback books for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?
Answer
a. $600,000
b. $466,667
c. $333,333
d. $200,000
e. None of the above

Answer:

To solve for a Break Even point we must use the identity [Q*(P-VC)] - FC = Profit
where:
Q = quantity or number of units
P = the sales price per unit
VC = variable cost per unit
FC = total fixed cost

They give us P = $7, VC = $5 and FC = $200,000. That means that 200,000 * (7-5) - FC = 0.
If we solve for zero we find that FC is $400,000.

Now they tell us that VC will fall to $4 per unit and we must find the NEW breakeven point. That means 200,000 * (7-4) - FC = 0. Solving for this equation we get our NEW fixed cost amount of $600,000.

When we started at a VC of $5 a unit, our FC for breaking even was $400,000. Now at $4 per VC we have a FC of $600,000, an increase of $200,000 in advertising as a fixed cost. The answer is (d).