Question

Joanna is looking at her business numbers and making a plan for next year. She feels like her sales margins are too small, but drastic price increases may severely impact her sales volume. Sales totaled 80,000 units this year, resulting in net sales revenue of $320,000. Joanna feels that a $0.25 per unit price increase won’t impact sales, but a $0.50 increase will cause a 20% volume drop. Hence, she is leaning towards only increasing prices by $0.25.

She is planning to invest in new equipment (annual lease expense of $20,000), which will reduce her production costs for each unit manufactured. This year, the unit cost was $2, and Joanna is confident that it will drop by 25% next year.

Discuss Joanna’s business strategy in detail and its impact on the business’s Cost-Volume-Profit graph (how will it change next year). Include any questions you might want to ask Joanna and why they are relevant/helpful to your analysis.

Answer 1

Joanna plans for the following proposal

Existing : if no change in last year production , selling price and cost

80000 Units @ $ 4 per unit

Net Sales value : $ 3,20,000

Sales : No change

Cost : No change

Profit : No change

Proposal 1 : no change in voloume with increase in selling price and additional expense & reduction of production cost

80000 Units @ $ 4.25 per unit

Net Sales Value : $ 3,40,000 ,

Incremental Revenue : $ 20,000 ( Due to increase in selling price $ 3,40,000 - $ 3,20,000)

Incremental Revenue : $ 40,000 ( Due to reduction of production cost by $0.50 for 80000 Units. ( $ 2 *25% = $0.50)

Incremental Expense : $ 20,000 ( Annual Lease Agreement)

Net increase in Profit : $ 40,000

Sales : Increase revenue by $ 20,000

Cost : Reduce $ 0.50 per unit for additional expense of $ 20,000 per year and gross cost saving of $ 40,000

Profit : $40,000 incremental profit

Proposal 3 : Increase in Selling price by $ 0.50 & reduction of Voloume by 20% from last year

64000 Units @ 4.50 per unit

Net Sales Value : $ 2,88,000

Sales Revenue loss :$ 32,000 ( Due to increase in price $ 3,20,000 - $ 2,80,000)

Sales : Revenue loss by $ 32,000

Cost : No change

Profit : Loss of $ 32,000

While considering the proposals above, suggested that Joanna can go with Proposal 1 as it clearly showing increase in profit.

* assumed that cost remain same irrespective of change in voloume.

Proposal Suggested for reference

Another Proposal suggested for consideration is reduction of $ 0.25 in Selling price per unit with a target of 15 % increase in voloume. Which will result in a  additional increase in profit by $ 25,000 ( 92000 @ $3.75 = $ 3,45,000 Less $ 3,20,000). provided cost remains sames and plant have unutilized capacity

Along with the above proposal if she went for additional invest in machinery. incremental revenue of $ 20, 000 will be added. ( reduction in cost $ 40,000 Less Lease Expense $ 20,000).

Moreover fixed cost can be further reduced by increased capacity & manpower utilization

So total $ 45,000 can be additional profit. Which is better than Proposal 1.