Question

You operate a lemonade stand. The wholesale cost of lemonade Is $0.50 per unit. The cost of rent for the stand is $50 per day. You need to choose your pricing and advertising strategy. You are considering alternatives: A: If you set the selling price to $1.50 per unit and spend $0 on advertising, you will sell 120 units per day U: If you reduce the selling price to $1.20 per unit and spend $0 on advertising, you wll sell 180 units per day. C: It you set the selling price to $1.50 per unit and spend $30 per day on advertising, you will sell 180 units per day. a) Compute revenuc, costs, and profit per day for each alternative. 8 Revenue Costs Lemonade (wholesale) Rent Advertising Profit b) Which alternative should you choosc? O c c) Is rent a relevant cost? O NO (the cost Is the same for all three alternatives; It can be lgnored) O YES (the cost difters across alternatives; it should not be ignored) d) Is advertising a relevant cost? O YES (the cost differs across alternatives; It should not be ignored) ○ NO (the cost is the same for all three alternatives; it can he ignored)

Answer 1

a)
	A	B	C
Revenue (i)	120 x 1.50 = $180	180 x 1.20 = $216	180 x 1.50 = $270
Costs:(ii)
Lemonade	120*0.50=$60	180 x 0.50 = 90	180x 0.50 = 90
Rent	50	50	50
Advertising	0	0	30
Profit (i) - (ii)	$           70.00	$            76.00	$          100.00
b)
Since profit is maximum is option C, hence option C must be chosen
c)
Rent is not a relevant cost since rent is same for all the three alternatives, it can be ignored. Cost which does not change in different alternatives, is not a relevant cost in decision making.
d)
Advertising is a relevant cost since advertising differs across different alternatives, it should not be ignored. Cost which changes id different alternatives, is a relevant cost in decision making.