Question

Diana Suares is aware that unless the company changes its strategy in some way, its operations in 2017 will be unprofitable. Alternative marketing plans for 2017 are summarized below. 

Plan A: Cut price At the present time we price the product to retailers at $8.00 per rattle. Retailers generally charge the consumers between $9.00 and $9.50. If we cut our price to retailers to $7.50, I expect that the product will do much better. Their increased markup will give them the incentive to display our product more prominently and to promote it more vigorously to customers. We should support this strategy by supplying more promotional materials to retailers, at least another $200 worth to each of our 23 retailers. I expect that we will be able to boost our sales volume by as much as 30 percent.

Plan B: Better packaging We have a well-designed, safe product which should be very appealing to affluent parents. However, our packaging appears cheap and unattractive. Some of our retailers feel that our product seems out of place in their store. If we improve our packaging, we should be able to boost sales. We have worked with our regular supplier to develop a new type of package that should boost sales by anywhere from 20 to 30 percent. They are willing to supply us the new packaging for $1.25 per unit. 

1. Prepare an income statement for 2017, using the contribution format under Plan A. Ignore income taxes.

2. What is the profit equation (as a function of volume) under Plan (A)? Plan (B)?

3. (a) There is one volume of sales at which both marketing plans give identical income (or loss). What is this volume? (b) Which plan would give higher income if the volume is (i) above and (ii) below the volume calculated in part (a). Why?

4. Donn Capp, the CFO, suspects that indirect labor costs, which the company has traditionally viewed as being variable, may actually be a mixed cost. In March 2016 when the production volume was at a low of 15,000 units, the indirect labor cost was $4,000. In September 2016 when production volume was at its highest level (40,000 units), the indirect labor cost was $9,000. What would be your estimate of the total indirect labor cost for the year under Plan A (i.e. for 390,000 units)? Assume the cost would be unaffected by inflation.