Question

JC Inc. produces and sells marbles. JC produces and sells 40,000 units at $5 per marble and has capacity for 50,000 units. Costs are as follows:

Variable production costs: $2 per unit produced

Variable marketing costs: $0.50 per unit sold

Fixed production costs: $30,000

Fixed marketing costs: $15,000

Fixed administrative costs: $15,000

1.JC is considering increasing sales by paying a sales commission for each unit sold. To increase sales by 10,000 units, what is the maximum commission per unit JC should be willing to pay?

2.JC is also considering increasing sales with an advertising campaign (instead of sales commissions). What is the most JC should spend on advertising to increase sales by 10,000 units?

3.Assume there are no changes in commissions or advertising. JC has received an order for 20,000 marbles at a price of $4 per marble. If JC accepts the offer, by how much will profits change?

Answer 1

Solution 1:

Sale price = $5

Variable costs per unit = Variable Manufacturing cost +Variable Marketing cost = $2 + $0.50 = $2.50

Contribution margin = Sale price - variable cost = $5 -$2.5 = $2.5

Maximum Sale commisions = Total contribution margin from 10000 units = 10,000*$2.5 = $25,000

Maximum commission per unit = Total sale Commission / Total units = $25,000 / (40,000+10,000)

= $25000 / 50000 = $0.50 per unit

Solution 2:

Maximumt amount to spend on advertising = contribution margin from increases sale of 10,000 units

= 10,000*2.5 = $25,000

Solution 3:

If order is accepted for 20,000 units then contribution margin from 20,000 units = 20,000* (selling price- variable costs) = 20000* ($4 -$2.5) = $30,000

if order is accepted, 10,000 sale units will be reduced from regular sales, therefore loss of contribution margin from regular 10,000 sale units = 10000* 2.5 = $25000

Increase in profit if order is accepted = Contribution margin from order accepted - loss of contribution margin due to decreases regular sale = $30,000 - $25,000 = $5,000 increase