Question

Jeb is the owner of a small-scale chocolate factory operated in South Burnaby area. Jeb sells a variety of chocolate products via Sam Foods (a food distributor) to local food retailers in the Burnaby area.

Jeb recently added a new line of premium Hazelnut chocolates to his existing Milk chocolate product line. After some initial research, Jeb is planning to sell a pack of Hazelnut chocolates to Sam Foods at an introductory price of $12 a pack (for the first year of its launch). During the first six months after the launch, Jeb sold 2400 packs of Hazelnut chocolates to Sam Foods.

[1] Jeb’s target is to make a 28% gross mark-up (on Jeb’s selling price) on all new products that he sells to Sam Foods. If Jeb is to make this profit target %, what is the maximum cost Jeb should incur in manufacturing a pack of Hazelnut chocolates.

[2] Calculate Jeb’s gross margin % for a Hazelnut chocolate pack. Is there a difference between the margin and the mark up %? Why? Explain.  

[3] Sam Foods makes profits by adding a 25% margin to the price he pays to Jeb. Local food retailers usually mark-up chocolate products by 32% in setting retail prices. Considering the above, calculate the final price paid by the end consumers for a pack of Hazelnut chocolates. Show your work clearly.

Jeb noticed Hazelnut chocolates were cannibalizing 40% of their regular Milk chocolate packs purchased by Sam Foods during this same period. Jeb sells regular Milk chocolates to Sam Foods at $10 a pack with a 35% margin. The cost structure of milk chocolates is the same the Hazelnut chocolates.

Jeb is interested to calculate his breakeven sales volume for the Hazelnut chocolate product line. 65% of the total cost of the Hazelnut chocolates (answer to Q1) were variable costs. The fixed costs to set up and launch Hazelnut chocolates were $15,000.  

[4] What is Jeb’s break-even volume for Hazelnut chocolates? What is Jeb’s profit or loss from Hazelnut chocolates based on his current level of sales (six months)?

[5] Using the DIKW model, should jeb continue sell Hazelnut chocolates at the expenses of his milk chocolate product line? What is your advice to Jeb?

Answer 1

Required 1.

Selling price of Hazzlenut chocolates = $12 per pack

Target Gross Mark-up = 28%

Thus if cost of the chocolates is X

Markup = 0.28X.

We know that,

Selling price = Cost + Markup

=> 12 = X + .28X

=> X = 9.375

Thus maximum cost of Hezzlenut chocolate could be $9.375 per pack

Required 2

Gross margin % = (Selling Price - Cost of Goods sold) ./ Selling Price *100

= (12 - 9.375) /12 * 100

= 21.875%

Yes there is a difference between the Gross margin % and markup %. The reason for the difference is:

Gross margin % is calculated by expressing gross profit as a percentage of selling price whereas markup % is calculated by expressing gross profit as a percentage of cost price.

Required 3

Let Sam Foods sell the hazzlenut chocolates to local retailers at Y per pack

Gross margin of Sam foods = 25%

therefore Sam foods earn a Gross Profit of 0.25Y

Now, we know

Selling price - Cost Price = Gross Profit

Y - 12 = 0.25Y

Y = $16

Thus, Sam foods sale the hazzlenut chocolate for $16 per pack

Markup % by retail stores = 32%

Therefore Final selling price to end consumers = $16 + 32% of $16 = $21.12

Required 4

Calculation of Break even volume for HazzleNut choclates:

Cost Price of Hazzle Nut choclates = $9.375 per pack

Variable Portion of the cost = 65% of $9.375 = 6.09375 per pack

Contribution margin per unit = 12 - 6.09375 = $5.90625

Fixed portion of cost per unit = 9.375 - 6.09375 = $3.28125

Total number of packs produced and sold = 2400

Total fixed manufacturing cost = $3.28125 * 2400 = $7875

Break even volume = Fixed cost / Contribution per unit = $7875 / 5.90625 = 1333.33 packs

Profit based on current level of sales = 5.90625 * 2400 - 7875 = $6,300

Note: One time set up cost is not considered while calculating the break even volume.

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