Question

Goal:
Please answer the questions below. The main goal of this homework is to see if you can calculate the profit maximization point for this small wedding cake business. I hope that you will be able to merge your knowledge of basic accounting and microeconomic theory in order to calculate the profit maximization point, make comments about efficiency, and make logical recommendations to the firm's management to ensure their future success.

Current Situation:
The local wedding cake business was very competitive during 2012. Delicious Deserts was the only wedding cake bakery in the entire county of two million people for several years. They often charged as much as $300 to $500 for each wedding cake. But a new competitor recently came into the market and started selling "discount wedding cakes" for less than $150. The quality and the taste of the discount wedding cakes were acceptable for most of their customers. Both businesses operated in a low-to moderate-income county in California where the average household income was not much higher than $40,000 per year.

The Challenge For Delicious Deserts:
At first the news of a low-cost competitor was terrible news for Delicious Deserts. They had no choice. They had to charge from $300 to $500 per wedding cake to cover their high costs. However, because of this new competition, the husband and wife owners of Delicious Deserts decided to make the business more efficient and lower costs. They invested in better ovens and created better tasting cakes using special ingredients. Their customers went crazy over their new and unique 80 proof Italian Rum Wedding cake that actually got people slightly drunk if they ate more than three slices.

To boost sales during 2012 they hired part-time telemarketers and social media experts. They also increased their advertising in traditional media such as local wedding magazines. They also displayed eye-catching ads in local churches, entertainment centers and jewelry stores.

They also experimented with a new pricing model in which they lowered prices each quarter. Indeed, they found that as they lowered their prices, they sold more cakes. They hired an "A" student who took a microeconomics class with Professor Ed Torres to do an elasticity analysis. The student estimated that the price elasticity for wedding cakes was 1.25 (elastic) and that the income elasticity was 2.10 (a luxury good). The owners of Delicious Deserts were not aware of this information. The student told them that they made a huge pricing strategy error for many years by charging high prices on an elastic good within a low-to moderate-income county.

The profit and loss statement below shows that Delicious Deserts made a Total Revenue of $275,000 and sold 1,375 wedding cakes. During 2012, they made three times (3X) more than they did versus 2011. Of course, because they invested in new ovens, made more cakes, and hired new part-time staff, the cost of doing business also rose. The net profit for 2012 was a slim $32,175. The salary for a professional desert baker averaged $70,000 per year in California.

Please examine the profit and loss statement on the next page, then answer the questions on pages 4 through 6.  

Delicious Deserts, Incorporated
Income Statement For The Year Ending December 31, 2012

Revenues

Gross Sales....................................................................$275,000
Less: Sales Discounts ..................................................$ 2,500
Less: Returns (Cancelled Weddings)...........................$ 2,000
Net Sales...............................................................................................$270,500

Cost of Goods Sold

Beginning Inventory (January 1).................................$ 18,000
Cost Of Ingredients To Bake Cakes............................$109,500
Total Cost of Goods For Sale......................................$127,500
Less: Ending Inventory December 31.........................$ 15,000
Cost of Goods Sold..............................................................................$112,500

Gross Profit.....................................................................................................$158,000

Operating Expenses
Selling Expenses
Sales Commissions........................................$ 31,000
Advertising...................................................$ 16,000
Other Selling Expenses (Internet).................$ 18,000
Total Selling Expenses...............................................$ 65,000

General and Administrative Expenses
Professional & Office Salaries.................................$ 20,500
Utilities....................................................................$ 5,000
Office Supplies........................................................$ 1,500
Bank Interest Paid on Loans....................................$ 3,600
Insurance.................................................................$ 2,500
Rent (Fixed Cost)....................................................$ 17,000
Total General & Administrative Expense.............................$ 50,100
Total Operating Expenses..................................................$115,100

Net Profit Before Taxes..............................................................................$ 42,900
Less: Federal/State/Local Taxes................................................................$ 10,725
NET PROFIT.............................................................................................$ 32,175

   

Question #1:
What was the Total Fixed Cost of running this business?

Free Answer:
The rent was the only fixed cost that Delicious Deserts had. They paid $17,000 per year or $1,416.66 per month for rent. All other expenses were variable costs.

Question #2:
What was the Total Variable Cost of running this business?

Answer: $________________________________________

Clue:
Add up Cost of Goods Sold, Total Operating Expenses (less Rent), Income Tax Expense and include the write-off losses from Sales Discounts & Wedding Cancellations.


Question #3:
Assuming that Delicious Deserts sold 150 cakes during Q1, 300 cakes during Q2, 450 cakes during Q3, and 475 cakes during Q4, what was the Total Revenue during each quarter assuming the prices were: Q1 - $275 per cake, Q2 - $240 per cake, Q3 - $180 per cake and Q4 - $170 per cake?    

Q1 - Total Revenue = $____________________________

Q2 - Total Revenue = $____________________________

Q3 - Total Revenue = $____________________________

Q4 - Total Revenue = $____________________________

The "A" student did a quarterly cost breakdown analysis for Delicious Deserts. A month-to-month analysis would have been better, but the owners just wanted a quick quarterly analysis. Q1 = 150 cakes sold, Q2 = 300 cakes sold, Q3 = 450 cakes sold and Q4 = 475 sold.   

Quantity Sold	0	150	300	450	475
Demand/Price	$275	$275	$240	$180	$170
MR		$275	$205	$ 60	($ 10)
ATC		$238	$207	$153	$151
MC		$200	$175	$ 47	$283
TR		$41250	$72000	$81000	$80750
TC		$35750	$62000	$69000	$76075
Net Profit		$ 5500	$10000	$12000	$ 4675

Challenge Question #4:
Hint: Use the instructions on page 7 of the Excel 2016 handout.

Can you plot a nice-looking graph to show how the demand curve, the average total cost, marginal cost, and marginal revenue curves look like? Paste it on this page or attach a separate page to this homework.   

  

    

           

Question #5
What is the MC=MR Profit Maximization point? What quantity should Delicious Deserts be producing at 'and' what price should they be charging to maximize their profits?

Question #6
Why isn't it a good idea for them to produce and sell as many cakes as they can? Is it more profitable to sell less cakes at this current stage of their business?

Question #7
Do you have any other recommendations for Delicious Deserts to increase their revenues, profits, market share, and client retention?

Answer 1

Given data:

The local wedding cake business was very competitive during 2012.

They charged for each wedding cake = $300 to $500.

Discount wedding cakes for less than $150.

Where the average household income was not much higher than $40,000 per year.

The Challenge For Delicious Deserts:
They had to charge = $300 to $500 per wedding cake.

The student estimated that the price elasticity for wedding cakes was 1.25 (elastic)

That the income elasticity was 2.10 (a luxury good).

Total Revenue of $275,000 and sold 1,375 wedding cakes.

The net profit for 2012 was a slim $32,175.

The salary for a professional desert baker averaged $70,000 per year in California.

Question 2:

Variable cost = {Total Operating Expenses [$115,100]- Rent [$17000]} + Cost of Goods For Sale[$127,500] + Federal/State/Local Taxes[$ 10,725]

Variable cost= $236,325

Question 3:

Total revenue = Price * Quantity

Q1 - Total Revenue =$275*150= $41250

Q2 - Total Revenue = $240*300= $72000

Q3 - Total Revenue = $180*450= $81000

Q4 - Total Revenue = $170*475= $80750

Question 5: Data for MR and MC is missing

but to solve this question firstly Equate MR=MC AND WHERE THESE BOTH INTERSECT this is the place where equilibrium price and quantity lies which gives maximum profit as at this point gap between TR [total revenue earned ]and TC [total cost incurred] is maximum and this gap indicates the profit earned.

Question 6: It is not a good idea to sell all those they can produce as producing the limit above which we have more cost then it will result out in losses. Thus maximum production should be done till the time MR [marginal revenue from each unit produced becomes zero] as after this value added to total production will start falling and maximum is earned when MR = MC.

For clear answer precisely please update question in properly structured manner with complete information.

I hope theory mentioned will help you.