Question

WSR Inc. sells a variety of drink and food products including potato chips and sodas. The segmented income statements for these two products are as follows:

	Sodas		Chips
Sales	$800,000		$900,000
Variable expenses	200,000		315,000
Contribution margin	600,000		585,000
Traceable fixed expense	120,000		160,000
Segment margin	$480,000		$425,000

WSR's management is considering a special advertising campaign that will run during a major sporting event. The advertising campaign is expected to cost $30,000 and only one product can be featured. In-house marketing studies show that the $30,000 advertising campaign could (1) increase sales of the soda division by 25% or (2) increase the selling price of the chips division by 20%.

   16.   Refer to the WSR Inc. information above. What will be the overall net effect on the company's total profits if the $30,000 advertising focuses on sodas with its 25% increase in sales?

a.	Increase of $170,000
b.	Increase of $150,000
c.	Increase of $120,000
d.	Increase of $200,000

17.      Refer to the WSR Inc. information above. What will be the overall net effect on the company's total profits if the $30,000 advertising focuses on chips with its 20% increase in the selling price?

a.	Increase of $170,000
b.	Increase of $150,000
c.	Increase of $120,000
d.	Increase of $200,000

Answer 1

16. With the increase in sales of Soda, there will be a proportionate increase in variable cost as there is change in quantity of goods sold, which implies there will be a proportionate change increase in Contribution Margin.

Fixed costs already allocated will not be impacted but there will be an increase in cost of Advertisement expenses.

Therefore, overall impact on net profit = Increase in contribution Margin - Advertisement Expenses

Increase in contribution Margin = $600,000*25% = $150,000

Therefore, overall impact on net profit = $150,000 - $30,000 = $120,000

Hence, option c. i.e. increase of $120,000 is the correct answer.

17. As there is change in selling price only, variable cost will not be effected as there is no change in quantity sold.

Increase in contribution Margin = Increase in sales price = $900,000*20% = $180,000

Therefore, overall impact on net profit = $180,000 - $30,000 = $150,000

Hence, option b. i.e. increase of $150,000 is the correct answer.