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.

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

Answer:

Cost per unit = R100

Original sales price = Cost + 60% mark up on cost = 100 + 60% * 100 = R160

Scenario A:

Per Month:

Company sold = 600 units

Sale value = 160 * 600 = R96,000

Cost = 100 * 600 = R60,000

Fixed cost = R8,000

Scenario B:

Per Month:

Company sold = 800 units

Sales price = 160 * (1 - 20%) = R128

Sale value = 128 * 800 = R102,400

Cost = 100 * 800 = R80,000

Fixed cost = R8,000

Scenario C:

Per Month:

Company sold = 1000 units

Sales price = 160 * (1 - 20%) = R128

Sale value = 128 * 1000 = R128,000

Cost = 100 * 1000 = R100,000

Fixed cost = R8,000

Additional marketing cost = R3,000

Calculation of net profit before Tax:

You would recommend Scenario A to management

Reason:

Scenario A results in highest net profit before taxes.