Question

1. The world-famous discounter, Fernwood Booksellers, specializes in selling paperbacks for $7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just breaking even. It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1. Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?

   (Hint: Find the fixed cost for both alternatives.)

   		$600,000
   		$466,667
   		$333,333
   		$200,000
   		None of the above

**Please show your work. Thank you for your help!

Answer 1

Given the current Price of paperback = $7

Variable cost per paperback = $5

Contribution per paperback = Sales - Variable Cost

= $7 - $5

=$2

Now given that the booksellers breakevens at 200000 units of paperbacks.

Now Breakeven unit = Fixed Cost/Contirbution Margin.

Therefore Fixed Cost = Breakeven Units * Contribution Margin

=$ 2* 200000 units

=$ 400000

Therefore on the above basis

Operating Income of the bookseller = Sales - Variable Cost - Fixed Cost

=($ 7 - $5)*200000 Paperback - $400000

= 0

Now given that variable cost will decrease by $1, this savings can then be used to increase the spending on advertising and still breakeven

Operating Income will be 0

Sales - Variable Cost - Fixed Cost - Advertising Revenue = 0

0=($ 7 - $4)*200000 - $400000 - Advertising Revenue

Advertising Revenue = $600000 - $400000

Advertising Revenue = $200000

Therefore the company can spend a further of $ 200000 on Advertising.