Question

The group product manager for ointments at American Therapeutic Corporations was reviewing price and promotion alternatives for two products: Rash-Away and Red-Away. Both products were designed to reduce skin irritation, but Red-Away was primarily a cosmetic treatment whereas Rash-Away also included a compound that eliminated the rash.
The price and promotion alternatives recommended for the two products by their respective brand managers included the possibility of using additional promotion or a price reduction to stimulate sales volume. A volume, price, and cost summary for the products follows:

Rash-Away
Unit price: $2.00
Unit Variable Costs: $1.40
Unit contribution: $0.60
Unit Volume: 1,000,000 units

Red-Away
Unit price: $1.00
Unit Variable Costs: $0.25
Unit contribution: $0.75
Unit volume: 1,500,000 units

Both brand managers included a recommendation to either reduce price by 10% or invest an incremental $150,000 in advertising.

a) What absolute increase in unit sales and dollar sales will be necessary to recoup the incremental increase in advertising expenditures for Rash-Away? For Red-Away?

b) How many additional sales dollars must be produced to cover each $1.00 of incremental advertising for Rash-Away? For Red-Away?

c) What absolute increase in unit sales and dollar sales will be necessary to maintain the level of total contribution dollars if the price of each product is reduced by 10%?

Please guide me by giving a step by step working out about this question.. thank you!

Answer 1

Rash-Away Red-Away

Selling price per / unit 2.00 1.00
Variable cost 1.40 0.25
Contribution per unit 0.60 0.75
No. of units 1,000,000 1,500,000
Total contribution 600,000 1,125,000

(a)
Advertisement cost 150,000 150,000
Incremental sales /units
(Advertisement cost/Contribution per unit)
150,000 / .060 150,000/.75
250,000 units 200,000 units
Incremental Dollar sales 250,000 X 2 200,000 X 1
(Units sales X Selling price) $500,000 $200,000

(b) For each $1 increment in advertising cost, the additional sales dollars required will be

Rash-Away Red-Away
2.00/0.60 1/0.75
= 3.33 = 1.33

© If the price is reduced by 10%
Rash-Away Red-Away
Selling price per / unit 1.80 0.90
Variable cost 1.40 0.25
Contribution per unit 0.40 0.65
Total contribution 600,000 1,125,000
Required
No. of units necessary to be sold 600,000/.40 1,125,000/.65
(Contribution required/ contribution
Per unit) =1,500,000 1,500,000

Sales in dollars 1,500,000 X 1.80 1,500,000 X 0.90
(Units X Selling Price Per unit) = $2,700,000 = $1,350,000

Answer 2

Computing the absolute increase in Unit sales and dollar sales to recoup the incremental increase in the advertising expenditure for Rash Away and Red-Away.
To determine the increase in Unit sales and dollar sales, we have to compute the Contribution margin ratio for the two products.
For Rash-Away:
Contribution margin = (Selling price per unit - Variable cost per unit) / SP per unit
= ($2.00 - $1.40) / $2.00
= $0.6 / $2.0
= 0.30 or 30%
Absolute increase in Unit sales for Rash-Away is calculated by dividing the advertising expense by contribution margin per unit.
Increase in Unit sales = $150,000 / $0.6
= 250,000 units
Absolute increase in Dollar sales for Rash-Away is calculated by dividing the advertising expense by contribution margin ratio.
Increase in Dollar sales = $150,000 / 0.30
= $500,000
For Red-Away:
Contribution margin = (Selling price per unit - Variable cost per unit) / SP per unit
= ($1.00 - $0.25) / $1.00
= $0.75 / $1.0
= 0.75 or 75%
Absolute increase in Unit sales for Red-Away is calculated by dividing the advertising expense by contribution margin per unit.
Increase in Unit sales = $150,000 / $0.75
= 200,000 units
Absolute increase in Dollar sales for Red-Away is calculated by dividing the advertising expense by contribution margin ratio.
Increase in Dollar sales = $150,000 / 0.75
= $200,000

Answer 3

Rash-Away Red-Away

Selling price per / unit 2.00 1.00
Variable cost 1.40 0.25
Contribution per unit 0.60 0.75
No. of units 1,000,000 1,500,000
Total contribution 600,000 1,125,000

(a)
Advertisement cost 150,000 150,000
Incremental sales /units
(Advertisement cost/Contribution per unit)
150,000 / .060 150,000/.75
250,000 units 200,000 units
Incremental Dollar sales 250,000 X 2 200,000 X 1
(Units sales X Selling price) $500,000 $200,000

(b) For each $1 increment in advertising cost, the additional sales dollars required will be

Rash-Away Red-Away
2.00/0.60 1/0.75
= 3.33 = 1.33

© If the price is reduced by 10%
Rash-Away Red-Away
Selling price per / unit 1.80 0.90
Variable cost 1.40 0.25
Contribution per unit 0.40 0.65
Total contribution 600,000 1,125,000
Required
No. of units necessary to be sold 600,000/.40 1,125,000/.65
(Contribution required/ contribution
Per unit) =1,500,000 1,500,000

Sales in dollars 1,500,000 X 1.80 1,500,000 X 0.90
(Units X Selling Price Per unit) = $2,700,000 = $1,350,000