Question

A friend of your parents owns a pizza restaurant. The owner is disappointed with his restaurant’s performance. Your parents tell him that you are taking Strategic Cost Accounting at Loyola and maybe you can help him figure out what might be the issue.

The restaurant sales have been averaging 3,000 pizza sales (at $10 each) per month, but the cooks and wait staff can make and serve 5,000 pizzas per month The average ingredient cost for each pizza is $2.00. Monthly costs for depreciation, property taxes, business license, manager’s salary and so forth are $6,000 per month.

A. First, the owner would like information at several different levels of operations: 2,500 pizzas, 3,000 pizzas, and 5,000 pizzas. Make a nice looking chart to present this information so the owner can easily interpret it. (Presentation of accounting data will be part of your job!)

B. From a cost standpoint, why would restaurants (or any business really) want to operate at near or full capacity?

C. The owner has been considering other ways to increase sales volume, such as cutting the price of pizzas to $9.50 each. He thinks could then sell 5,000 pizzas per month. Show him what might happen from this decision. How much extra profit above his current level would he generate (or lose) from dropping the sales price? Should he do this?

D. The owner’s other idea is to advertise his restaurant on the local radio stations. If he kept the sales price at $10 per pizza, the advertising agency claims he would have to spend $10,000 per month to increase monthly sales to 5,000 pizzas. How much extra profit above his current level would he generate (or lose) by keeping the sales price per pizza at $10 and advertising on the radio? Should he do this?

E. The owner had thought because the current average profit margin per pizza is $6.00, that the restaurant would make $30,000 of income per month (before advertising costs), if they sold 5,000 pizzas at the usual $10 per pizza. How did the owner get this figure and why is it wrong?  

Answer 1

A.

5,000 10 Unit Sold Sale Price ($) per Unit Total Sales Average Ingredient Cost $ @ 2 Per Unit Contribution Margin Contribution Margin Per Unit Fixed Cost (Depreciation, Manager Salary, Property Taxes, Business Licence) Margin Margin Per Unit 2,500 3,000 10 10 25,000 30,000 5,000 6,000 20,000 24,000 8 8 50,000 10,000 40,000 8 6,000 6,000 6,000 14,000 18,000 5.60 6.00 34,000 6.80

6,000 5,000 6.80 4,000 3,000 6.00 Margin Per Unit -Unit Sold 5.60 2,000 1,000 1 2 3

B. why would restaurants (or any business really) want to operate at near or full capacity?

Because, We have to incurred same Fixed Cost for all Level of Capacity, in our example, if you see table in Answer 1, Restaurant had incurred fixed cost of $ 6000 at level of capacity (2500, 3000, 5000), Fixed Cost Per Unit is Variable, i.e @ 2500 Pizas, 2.4 Per unit, @ 3000 Pizzas, 2 Per Unit and @ 5000 Pizzas, 1.2 Per Unit, it means as your sale increase in units, your Fixed cost per unit is come down, due to this as your per unit fixed cost come down, your margin per unit is goes up as shown in Answer 1 Table, thats why every business want to operate on full capacity.

C. How much extra profit above his current level would he generate (or lose) from dropping the sales price?

     With the decrease in per Unit Price 0.5 Per Unit, His Net Margin per Unit increase from 6 per unit 6.30 per unit, amount impact of same is $ 13500.

    Should he do this?

     This strategy looks fine with the numbers, but he need to verify his assumpation of increase in Sale quantity of pizzas by 2000 per month if he reduce per unit price to 9.5.

After Current Level reducing Price 3,000 5,000 10.0 9.5 30,000 47,500 6,000 10,000 24,000 37,500 Unit Sold Sale Price ($) per Unit Total Sales Average Ingredient Cost $ @ 2 Per Unit Contribution Margin Contribution Margin Per Unit Fixed Cost (Depreciation, Manager Salary, Property Taxes, Business Licence) Margin Margin Per Unit 8 8 6,000 6,000 18,000 6.00 31,500 6.30

D. How much extra profit above his current level would he generate (or lose) by keeping the sales price per pizza at $10 and advertising on the radio?

He would generate $ 6000 more per month with this decision, it's a positive in amount but it's negative @ Per unit level by 1.2 per unit.

Should he do this?

I would suggest him to go ahead with his decision, because even Per unit margin is reducing but he will get Net margin of $ 6000 more per month, in this case also he need to verify the sales number after advertisement.

Current Level After Advertisemnt 3,000 10.0 30,000 6,000 24,000 Unit Sold Sale Price ($) per Unit Total Sales Average Ingredient Cost $ @ 2 Per Unit Contribution Margin Contribution Margin Per Unit Fixed Cost (Depreciation, Manager Salary, Property Taxes, Business Licence), Advertisement in 2nd case. Margin Margin Per Unit 5,000 10.0 50,000 10,000 40,000 8 8 6,000 16,000 18,000 6.00 24,000 4.80

E. As already shown in Answer A's Table, if he sells 5000 pizzas per month without advertising cost, he will get Profit margin of $ 6.80 per unit in amount $ 34000 per month and not $ 30000 and if he spend advertising expenses for getting sale of 5000 pizas then he will get pfofit of $ 24000 per month (Refer toble in Aswer of D) but per unit profit will goes down $ 4.8.