Question

Gelmite & Sons Hardware is considering introducing a cash discount policy to its customers so as to

improve current sales. There are three possible scenarios that include monthly estimates. Gelmite

& Sons uses a 60% mark up on cost on all their products as a general rule. Fixed costs are R8 000

per month.

Scenario A: Representing the Current Scenario

Company sold 600 units of the spark nail which they ordered at a wholesaler in Shoppers Town for

a cost price of R100 each.

Scenario B: Representing initial sales target

Company will sell 800 units of the spark nail which they ordered at a wholesaler in Shoppers Town

for a cost price of R100 each.

These sales units are achieved after the introduction of a 20% markdown on the original selling

price.

19; 20 2020

© The Independent Institute of Education (Pty) Ltd 2020

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Scenario C: Representing a scenario where sales targets are surpassed

Company will sell 1 000 units of the spark nail which they ordered at a wholesaler in Shoppers Town

for a cost price of R100 each. In order to achieve the increased sales, additional marketing costs of

R3 000 will be incurred.

These sales units are achieved after the introduction of a 20% markdown from original selling price.

Required:

Which of the three scenarios would you recommend to management? Provide a reason for your

answer with reference to net profit before tax.

Answer 1

Cost per unit = R100

Sales Price Initially = Cost + 60% markup on cost = 100 + 60%* 100 = R160

Scenario A
Per Month
Company Sold	600	units
Sale Value	160*600	96000
Cost	100*600	60000
Fixed Cost		8000
Scenario B
Per Month
Company Sold	800	units
Sales Price (per unit)	160*(1-20%)	128
Sale Value	128*800	102400
Cost	100*800	80000
Fixed Cost		8000
Scenario C
Per Month
Company Sold	1000	units
Sales Price (per unit)	160*(1-20%)	128
Sale Value	128*1000	128000
Cost	100*1000	100000
Fixed Cost		8000
Additional Marketing cost		3000
Calculation of net profit before tax
	Scenario A	Scenario B	Scenario C
Sales Value	96000	102400	128000
Cost of Good Sold	60000	80000	100000
Gross Profit	36000	22400	28000
Fixed Cost	8000	8000	8000
Additional Marketing Cost			3000
Net Profit before Tax	28000	14400	17000
One should recommend Scenario A to the management as it has highest Net Profit before tax among the three scenarios.