Question

Lisa MacIntosh is the product manager for the Genius Smartwatch Manufacturing Company.   The company has total fixed costs of $6,090,000 for the coming year. The owner estimates that variable costs for this smartwatch will be $130. The company sells its product directly to selective retailers and the retail selling price will be $450. The Genius Company has priced its smartwatch so that the retailer will earn a 40% markup on the watch. The total market for this style of watch is currently 800,000 and Genius has a 15% market share.

A.         What price is the Genius Company charging its retailers for the watch? What is the manufacturer’s contribution per unit and the contribution margin percentage for each smartwatch sold to the retailer?   (3 points)

B.         How many units must be sold in order for Genius to break even? Is                              the smartwatch profitable? What is its profit or loss? (2 points)

C.         The Genius company's marketing director wants to generate profits

equal to 20% of sales for the watch line. How many units must be produced and sold in order to achieve this target return? What sales revenue must be generated in order to meet this target return? (2 points)

D.         Ms. MacIntosh is recommending that the advertising budget be

increased by $200,000. As a result of this increased spending on advertising, she expects to increase sales by 8%. Assuming that her forecast is correct, should the advertising budget be increased? What is the break even for the additional expenditure in units? What is the profit impact of such a move? (3 points)

E.         Ms. MacIntosh’s assistant just got a degree in economics and tells her that instead of increasing the advertising budget, she should decrease the price to the retailer by $20. He estimates that if she decreases the price to the retailer by $20, the company will be able to sell 8% more smartwatches to its retailers than she is currently selling. Mr. Wolf is considering the two alternative actions to increase profits: increase the advertising budget or decrease the price. Assuming her assistant’s forecast is correct, which action (increase advertising or decrease price) should Ms. MacIntosh recommend? What would the breakeven in units be after the decrease in price? What is the difference in profit between the two actions? (5 points)

Answer 1

Given,

Fixed costs = $6,090,000

Variable costs = $130.

Selling price will be $450.

Retailer earning = 40% markup.

[A.1.]

Sales per unit = 450 $

Markup = 40%

Selling Price for Retailers =

= (Markup % /100 % * Sales per unit) + Sales per unit

= (40% / 100% * 450 $) + 450

= (0.4 * 450 $) + 450 $

= 180 $ + 450 $ = 630 $

Therefore, the Genius Company will charge 630 $ to its retailers for the watch.

[A.2.a]

Selling price = $450

Variable cost = $130

Contribution margin per unit =Selling price - Variable cost

= $450 -$130= $320

Therefore, Manufacturer’s contribution per unit = $ 320

[A.2.b.]

Sale price = 450 $

Variable cost = 130$

Contribution margin = 320 $

Contribution margin percentage = Contribution margin / Sale price

= 320 $ / 450 $ = 0.71 = 71%

Therefore, contribution margin percentage for each smartwatch sold to retailer is 71 %

[B.1] Fixed costs = $6,090,000

Selling price = $450

Variable costs = $130.

Break-even point (in units) = Fixed cost / Contribution margin

= 6, 090, 000 $ / (450 $ - 130 $).

= 6, 090, 000 $ / 320 $

= 19, 031units

Therefore, given fixed costs, variable costs and selling price of the smartwatch Genius must need to sell 19,031 units to break even.

• If Genius sells more than 19, 031 units it will make profit
• If Genius sells less than 19, 031 units it will make loss

Sales revenue (19,031 units * $ 450 per unit) = 8, 563,950 $

Variable cost (19,031 units * $ 130 per unit) = 2, 474, 030 $

Gross Margin = 8, 563,950 - 2, 474, 030 = 6, 089, 920 $

Fixed Cost = $6,090,000

Net Loss = 6, 089, 920 $ - 6, 090, 000 $ = - 80 $

• No, smartwatch isn’t profitable. As, we have incurred loss

[C]

Profit = 20% of 450 $ = 90 $

Sale price = 450 $ + 90 $ = 540 $

Fixed costs = $6,090,000

Revised selling price = $ 540

Variable costs = $130.

Revised break-even point (in units) = Fixed cost / Contribution margin

= 6, 090, 000 $ / (540 $ - 130 $).

= 6, 090, 000 $ / 410 $

= 14,853 units

Therefore, 14, 853 units must be produced and sold in order to achieve the target return of 540 $.

Sales revenue (14, 853 units * $ 540 per unit) = 8, 020, 620 $

8, 020, 620 $ sales revenue must be generated in order to meet this target return.

[D]

Sales = $ 2, 00,000

Revised Sales = $ 2, 00,000 + 8% of $ 2, 00, 00 = $ 2, 00,000 + $ 16, 000 = $ 2, 16,000

Revised Contribution = $ 2, 16,000 - $ 130 = 2, 15, 870 $

Revised Break-even point (in units) = 6, 090, 000 $ / (2, 16,000 $ - 130 $).

= 6, 090, 000 $ / 2, 15, 870 $ = 28.211 units

Yes, there should increase in the advertising budget as the profit impact is 2, 00,000 = 2, 16,000, i.e. increase of $16,000. Break-even for the additional expenditure is 28.211 units.

P/V Ratio = (Contribution / Sales) = 2, 15, 870 $ / $ 2, 16,000 = 99.93 %

Break-even value = (Fixed cost / P/V Ratio) = 6, 090, 000 $ / 99.93 % = $ 6, 094, 265

Also,

Sales revenue (28.211 units * $ 2, 16,000 per unit) = 6,093,576 $

Variable cost (28.211 units * $ 130 per unit) = 3,667 $

Gross Margin = 6,093,576 $ - 3,667 $ = 6, 089, 909 $

Fixed Cost = $6,090,000

Net Loss = 6, 089, 909 $ - 6, 090, 000 $ = - 91 $

[E]

Sale price = 450 $

Decrease sale price = 450 $ - 20 $ = 430 $

If the sale price is 8 % more

Sales = 450 $ + 8% of $ 450 = 450 $ + 36 $ = 486 $

Revised Contribution = $ 486 - $ 130 = 356 $

Revised Break-even point (in units) = 6, 090, 000 $ / (486 $ - 130 $). = 6, 090, 000 $ / 356 $ = 17.106 units

Revised P/V Ratio = 356 $ / $ 486 = 73.25 %

Revised Break-even value = 6, 090, 000 $ / 73.25 % = $ 8, 313, 993

Also,

Sales revenue (17.106 units * $ 486 per unit) = 8, 313 $

Variable cost (17.106 units * $ 130 per unit) = 2, 223 $

Gross Margin = 8, 313 $ - 2, 223 $ = 6090 $

Fixed Cost = $6,090,000

Net Loss = 6090 $ - 6, 090, 000 $ = - 6, 083, 910 $

If 28.211 units are produced and sold, the result will be 91 $ loss and if 17.106 units are produced and sold, the result will be - 6, 083, 910 $. Therefore, Ms.Maclntosh’s should go for increasing in advertising budget as less loss is incurred in producing 28.211 units in comparison to 17.106 units produced by decreasing sale price.