Question

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $40 per unit. Variable expenses are $20.00 per unit, and fixed expenses total $160,000 per year. Its operating results for last year were as follows

Sales	$	1,000,000
Variable expenses		500,000
Contribution margin		500,000
Fixed expenses		160,000
Net operating income	$	340,000

Required:

Answer each question independently based on the original data:

5. The sales manager is convinced that a 10% reduction in the selling price, combined with a $69,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

b. Do you recommend implementing the sales manager's suggestions?

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.70 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $340,000 net operating income as last year? Do not prepare an income statement; use the incremental analysis approach.

Answer 1

The sales manager is convinced that a 10% reduction in the selling price, combined with a $69,000 increase in advertising, would increase this year's unit sales by 25%.

a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented?

Reduction in selling price by 10%
Particulars	Unit Sold	Per unit	Total
Sales	31250	$       36	$     11,25,000
Variable expenses	31250	$       20	$       6,25,000
Contribution margin			$       5,00,000
Fixed expenses			$       1,60,000
Advertisement Expenses			$         69,000
Net operating income			$       2,71,000
Woking Note
New Sales Price per unit	Amount
Last year price	$         40.00
10% reduction	$            4.00
New Sales Price per unit	$         36.00
New Sales Demand
Last year Sales qualtity	$ 25,000.00
Increse in sales @25%	$   6,250.00
New Sales Demand	$ 31,250.00

b. Do you recommend implementing the sales manager's suggestions?

Ans. No, it is not viable to recommend the above suggestion because it results in decrease in company net operational income. Extra unit sold would not be sufficient to maintain same margin because advertisement expenses leads to net profit down.

6. The president does not want to change the selling price. Instead, he wants to increase the sales commission by $1.70 per unit. He thinks that this move, combined with some increase in advertising, would increase this year's sales by 25%. How much could the president increase this year's advertising expense and still earn the same $340,000 net operating income as last year? Do not prepare an income statement; use the incremental analysis approach.

	Situation 1
	Increase sales commission and incurred advertisement expenses to maintain same operating profit
	Particulars	Unit Sold	Per unit	Total
	Sales	31250	$         40	$       12,50,000
Less	Variable expenses	31250	$         20	$         6,25,000
	Contribution margin			$         6,25,000
Less	Sales Commission	31250	$      1.70	$            53,125
Less	Fixed expenses			$         1,60,000
	Net operating income before Advertisement expenses			$         4,11,875	A
	Target operational income			$         3,40,000	B
	Maximum expenses can be incurred for advertisement			$                 71,875	A-B

How much could the president increase this year's advertising expense and still earn the same $340,000 net operating income as last year – Answer $71,875