Question

Kokomochi is considering the launch of an advertising campaign for its latest dessert​ product, the Mini Mochi Munch. Kokomochi plans to spend $ 4.4 million on​ TV, radio, and print advertising this year for the campaign. The ads are expected to boost sales of the Mini Mochi Munch by $ 8.2 million this year and $ 6.2 million next year. In​ addition, the company expects that new consumers who try the Mini Mochi Munch will be more likely to try​ Kokomochi's other products. As a​ result, sales of other products are expected to rise by $ 2.4 million each year. ​Kokomochi's gross profit margin for the Mini Mochi Munch is 32 %​, and its gross profit margin averages 23 % for all other products. The​ company's marginal corporate tax rate is 35 % both this year and next year. What are the incremental earnings associated with the advertising​ campaign?

Incremental Earnings Forecast	Year 1
Sales of Mini Mochi Munch	$
Other Sales	$
Cost of Goods Sold	$
Gross Profit	$
Selling, General, and Admin. Expenses	$
Depreciation		0
EBIT	$
Income tax at 35%	$
Unlevered Net Income	$

Answer 1

Calculation of incremental earnings associated with advertising​ campaign :

Particulars	Year 1 ($)	Year 2 ($)
(a) Sales of Mini Mochi Munch	8,200,000	6,200,000
(b) Other Sales (b)	2,400,000	2,400,000
(c) Less: Cost of Goods Sold = Sales - (1 - Gross profit %) (c) Mini Mochi Munch 1st year = 8,200,000 - (1 - 32%) Other Sales = 2,400,000 (1 - 23%) Total 1st year = 7,424,000 Mini Mochi Munch 2nd year = 6,200,000 - (1 - 32%) Other Sales = 2,400,000 (1 - 23%) Total 2nd year = 6,064,000	7,424,000	6,064,000
(d) Gross Profit (a) + (b) - (c)	3,176,000	2,536,000
(e) Less: Selling, General, and Admin. Expenses (only in 1st year)	4,400,000	0
(f) Less: Depreciation	0	0
(g) EBIT (d) - (e) - (f)	-1,224,000	2,536,000
(h) Less: Income Tax at 35%	0	887,600
(i) Unlevered Net Income (g) - (h)	-1,224,000	1,648,400

Hence, Kokomochi will suffer loss of $1,224,000 in the first year and profit of $1,648,400 in second year.

Note: Assumed no tax benefit is allowed in second year, for the loss suffered in first year.