Question

You are the plant accountant for a company that makes a popular brand of basketball shoes. Currently, your company sells 1,000 pairs of shoes each month for $100 apiece. The variable costs are 40% of sales, and the fixed costs are $35,000/month. The company's advertising director is asking for an increase in her marketing budget of $1,500 per month. She plans to enhance her marketing campaign in a targeted area of the West Coast. She estimates that the additional advertising will result in a 50% increase in demand. For this situation, the additional advertising costs are considered a fixed cost. What is the impact of this request on the company's operating income? On the other hand, the production manager believes that this increase in sales could put pressure on the production line. He estimates that there will need to be a $2.00 increase in labor costs per unit.

Consider the following:

Using the projected monthly income figure calculated above, how many units would the company need to sell to meet the initial monthly income figure?
What is the break-even sales volume needed?
Summarize the results of your analysis.
Respond to the following for this assignment:

How did you calculate the original operating income and break-even point before changes?
What is the new break-even point after including the effects of the increased advertising and higher variable costs?
Compare the two break-even results, and make a recommendation on whether the company should change or not.

Answer 1

sales Price	100
Variable Cost @ 40% of Sales Price	40
Contributio PU	60
Fixed Cost	35000
Current BEP	35000/60	583.3
Present profit @1000 Pair (Assuming Pair as a piece of shoes ) 1000*(60)-35000	25000
Increase in labour cost due to increase in sales ($2 PU) cosidering $ 2 shoes in a pair	4
New Variable Cost	44
New Contrbution (Old Contribution -increase in cost)	56
Increase in Advertisement Cost	1500
New Fixed Cost Per month Old fixed Cost + increase in cost	36500
New BEP (New Fix	651
New sales volume in Units (50% increase)	1500 Pair
Profit (1500*56-36500)	47500
As there is increase in Profit, the company should go for increase in advertisement Expenses

Comparison of Break even point in two scenarios

Since after increase of Advertisement expenses, the BEP has increased, but this has also changed the sales volume. The company should go for incurring these expense as even after incurring additional adverstisement and increased labour cost , the total profitabilty has inceased due to higher volume. This is also to be noted that increase in BEP level does not indicate that the company should leave to increase the activity level.

Remarks : There is no clarity in question w.r.t Price of shoe. it is shown as $100 a piece. If 2 piece are considered in a piece, the price would be changed as $200 and all calculations woud get changed.