Question

The Mineral Water Company sells bottled water for offices and homes. The price of the water is $20 per 10 gallon bottle and the company currently sells 2000 bottles per day. Following are the company’s income and costs on a daily basis:

Sales Revenue $40,000

Variable Cost $16,000

Fixed Cost $20,000

[Note: You can assume that variable costs are constant so that the average of them is also the unit variable cost.]

The company is enjoying stable demand with its current pricing, but management is looking for ways to increase profitability. One suggestion is that the company reposition its water as a premium product, justifying a higher price. If successful, the company believes that it could charge 20% more for its water than it does now.

1) What is the maximum sales loss (in % and units) that Mineral Water could tolerate before a 20% price increase would fail to make a positive contribution to its profitability (i.e., what is the basic break-even sales change)?

2) By how much would Mineral Water’s contribution increase/decrease if its sales declined by 15% following the price increase?

3) In order for Mineral Water to reposition as a premium water, management believes that it will have to upgrade the packaging of its product. The company will deliver the water in glass rather than plastic bottles and the bottles will be “safety sealed” to insure their cleanliness until the covering is removed in the customer’s home. These changes will add $1.00 per bottle to the variable cost of sales. What is the maximum sales loss Mineral Water could have for the 20% price increase to remain profitable?

4) To reposition its water as a premium product, Mineral Water will require an increase in its advertising and promotion budget of $900 daily (in addition to the increase in variable cost mentioned above). What is the maximum sales loss Mineral Water could tolerate before a 20% price increase would fail to increase its net profit?

5) Mineral Water’s management considers producing the bottles they use themselves instead of buying them from a supplier. This would reduce the variable cost (not paying the supplier), but in turn increase the fixed cost (additional machinery to produce the bottles).

Would this change make Mineral Water more or less likely to pursue the idea of the premium water? Please explain your answer.

Answer 1

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