Using fixed cost as a competitive business strategy
The following income statements illustrate different cost structures for two competing companies.
Income Statements | ||
| Company Name | |
| Hank | Rank |
Number of customers (a) | 80 | 80 |
Sales revenue (a × $250) | $20,000 | $20,000 |
Variable cost (a × $175) | N/A | (14,000) |
Variable cost (a × $0) | 0 | N/A |
Contribution margin | 20,000 | 6,000 |
Fixed cost | (14,000) | 0 |
Net income | $ 6,000 | $ 6,000 |
Required
a. Reconstruct Hank’s income statement, assuming that it serves 160 customers when it lures 80 customers away from Rank by lowering the sales price to $150 per customer.
b. Reconstruct Rank’s income statement, assuming that it serves 160 customers when it lures 80 customers away from Hank by lowering the sales price to $150 per customer.
c. Explain why the price-cutting strategy increased Hank Company’s profits but caused a net loss for Rank Company.
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