I have this homework problem that I’m stuck on. Any help would be GREATLY APPRECIATED!
There are 3 parts to it (a,b&c). Again any help will be helpful to me.
Thanks
Purple Cow operates a chain of drive-ins selling primarily ice cream products. The following information is taken from the records so a typical drive-in operated by the company:
Average selling price of ice cream per gallon $16.00
Number of gallons sold per month 3,000
Variable costs per gallon:
Ice cream $5.60
Supplies (cups, cones, toppings, etc.) 2.40
Total variable costs per gallon $ 8.00
Fixed costs per month:
Rent on building $ 2,200.
Utilities and upkeep 760.
Wages, including payroll taxes 4,840.
Manager’s salary, including payroll taxes but excluding any bonus 2,500.
Other fixed expenses 1,700.
Total fixed costs per month $12,000.
Based on these data, the monthly break-even sales volume is determined as follows:
$12,000 (fixed costs) = 1,500 gallons (or $24,000)
$8.00 (contribution margin per unit)
Requirements:
a. Currently, all store managers have contracts calling for a bonus of 20 cents per gallon for each gallon sold beyond the break-even point. Compute the number of gallons of ice cream that must be sold per month in order to earn a monthly operating income of $10,000 (round to the nearest gallon.)
b. To increase operating income, the company is considering the following two alternatives:
1. Reduce the selling price by an average of $2.00 per gallon. This action is expected to increase the number of gallons sold by 20%. (Under this plan, the manager would be paid a salary of $2,500 without receiving a bonus.)
2. Spend $3,000 per month on advertising without any change in selling price. This action is expected to increase the number of gallons sold by 10%. (Under this plan, the manager would be paid a salary of $2,500 without receiving a bonus.)
Which of these two alternatives would result in the higher monthly operating income? How many gallons must be sold per month under each alternative for a typical outlet to break even? Provide schedules to support all of your answers.
c. Draft a short memo to management indicating your recommendations with respect to these alternative marketing strategies.
EDIT: I reread the question and saw that the salary paid on the two new scenarios was no different from the original question, except for the deletion of the bonus. I therefore adjusted my original answer accordingly.
a. Currently, all store managers have contracts calling for a bonus of 20 cents per gallon for each gallon sold beyond the break-even point. Compute the number of gallons of ice cream that must be sold per month in order to earn a monthly operating income of $10,000 (round to the nearest gallon.)
Giving out a $0.20 per gallon bonus, once they have reached the breakeven point, lowers the contribution margin on the additional sales to $7.80 per gallon. The calculation of the additional gallons sold to achieve a $10,000 profit is:
$10,000 / $7.80 = 1,282
1,282 + 1,500 = 2,782 gallons that must be sold to achieve an operating income of $10,000
b. To increase operating income, the company is considering the following two alternatives:
1. Reduce the selling price by an average of $2.00 per gallon. This action is expected to increase the number of gallons sold by 20%. (Under this plan, the manager would be paid a salary of $2,500 without receiving a bonus.)
The thing that makes this problem hard is the fact that they don’t tell you what original sales volume number to use to base the calculations on. So I had to make a guess here, and used the 2,782 gallons they need to sell to earn the $10,000 of operating income.
Under this scenario the contribution margin goes down to $6.00 per gallon sold.
While Fixed costs stay the same at $12,000.
Assuming that the starting number of gallons sold was the 2,782 calculated in the first part, the new number of gallons sold would be 2,782 X 1.20 = 3,338 gallons per month.
Net Profit under this scenario would be:
(3,338 X 6.00) - $12,000 = $8,028
This is a reduction of $1,972 from the $10,000 they earned on the original plan.
2. Spend $3,000 per month on advertising without any change in selling price. This action is expected to increase the number of gallons sold by 10%. (Under this plan, the manager would be paid a salary of $2,500 without receiving a bonus.)
Under this scenario the contribution margin stays the same at $8.00 per gallon sold.
Fixed costs, though, increase to $15,000. ($12,000 + $3,000)
Assuming that the starting number of gallons sold was the 2,782 calculated in the first part, the new number of gallons sold would be 2,782 X 1.10 = 3,060 gallons per month.
Net Profit under this scenario would be:
(3,060 X 8.00) - $15,000 = $9,480
This is a reduction of $520 from the $10,000 they earned on the original plan, but a $1,452 improvement from the other option they are considering
c. Draft a short memo to management indicating your recommendations with respect to these alternative marketing strategies.
You’ll have to write this yourself, but while neither scenario looks good; the second one looks less bad than the first. If it were me, I would recommend that they enact neither of the two choices as both result in a lower profit margin than they already earn