In: Finance
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!
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.