Question

Hula Island is a Boutique Internet Shop that specializes in hand-painted glassware and Hawaiian-themed products. The company is a pure Internet shop without any brick-and-mortar stores. Internet advertising services offer Hula a variety of options, each with different pricing structures and outcomes. Management must use its resources wisely to generate sales, earnings, and cash flow. Students use their knowledge of Cost-Volume-Profit (CVP) relationships to make advertising decisions that affect short- and long-run profitability. Students then prepare cash budgets to support the timing of their advertising decisions.

Hula’s management believes that each customer generates $3.50 in short-run profit and $25 in lifetime profit. Calculate the advertising cost per conversion for Internet advertising Options 1 (Monthly Online Magazine) and 2 (Affiliated Retail Store). Calculate the total expected profit from each option (short-run and lifetime), as well as the ratio of total profit to advertising cost (short-run and lifetime). To determine the benefits of an advertising campaign, should Hula Island use the profit on the first sale or the expected lifetime profits? To choose between advertising campaigns, should Hula Island use the total expected profits or the ratio of total expected profits to advertising costs?

Note: Case – Hula Island is from the IMA Case Studies Journal

Table 2: Costs and Predicted Outcomes for each Advertising Option

Costs       Opt. 1 Mon. Online Magazine    Opt.2 Affiliated Retail Store    Opt. 3 Search Engine Variable                 $0.00                                          $0.25/click                          $0.005/click

Fixed                     $500                                            $50                                      Auction

Outcomes

Expected Clicks    1,550                                          5,780                                       84,000

Average Pg. views    20                                                5                                            1.5

% of Clicks Converted 7.00%                                    3.00%                                     0.14%

​​

Answer 1

The concept of CVP analysis is based on the relationship of Cost and volume of sales linked to generation of profit for the business , but some data is in sufficeint to caculate the actual BEP for the firm ,

The below calculation indicate on the both parameter of short run and life time profit ,option 3 is one of the most suitable for advertisement of the company , calculated below,

Costs	Opt. 1 Mon. Online Magazine	Opt.2 Affiliated Retail Store	Opt. 3 Search Engine
Variable	$0	$0.25/click	$0.005/click
Total variable cost		1445	420
Fixed	$500	$50	Auction
Total Cost	$500	$1,495	$420
Outcomes
Expected Clicks	1,550	5,780	84000
Average Pg. views	20	5	1.5
% of Clicks Converted	7%	3%	0.14%
Profit
Short term($3.5/client)	$379.75	$606.90	$411.60
Long Term ($25/client)	$2,712.50	$4,335.00	$2,940.00
Profit / Total cost
Short term	0.7595	0.405953177	0.98
Long term	5.425	2.899665552	7