Question

Toby's Shoe Company has one type of shoe in its shoe product line which is a running shoe. The detail on the production of this running shoe line:

Sales Price 40.00

Variable cost of goods sold 13.80

Variable selling expenses 10.60

Variable administrative expenses 13.00

Annual Fixed Costs:

Overhead 7,800,000

Selling Expenses 1,550,000

Administrative Expenses 3,400,000

Toby's Shoe Company is considering expanding the shoe product line by introducing a hiking shoe along with continuing to produce the running shoe. The hiking shoe is expected to sell for $90; costs of goods sold is expected to be $36.00 per pair.

If Toby's introduces the hiking shoe, the company will incur an additional $300,000 per year in advertising costs. Toby's marketing manager has estimated that one pair of hiking shoes would be sold for every four pair of running shoes.

A. If managers decide to introduce the hiking shoes, how many units (pairs) of each type of shoes would be required to break even in the coming year?

B. After additional research, Toby's marketing manager believes that if the price of the new hiking shoes drops to $66, it will be more attractive to potential customers. She also believes that at that price, the additional advertising cost could be cut to $177,600. These changes would result in sales of three pair of hiking shoes for every one pair of running shoes. Based on these circumstances, how many units of each type of shoes would be required to break even in the coming year?

C. What additional factors should the managers of Toby's consider before deciding to introduce the new hiking shoes? Would you recommend adding the new type of shoe on to the product line? Why, or why not?

Answer 1

A.

	Running Shoe	Hiking Shoe
	$	$
Sales Price	40	90
Variable COGS	13.80	36
Variable Selling and Administrative	23.60	23.60
Contribution Margin	2.60	30.40
Weighted Contribution Margin	2.60 x 4/5 = $ 2.08	30.40 x 1/5 = $ 6.08

Let the break-even units be Q.

At break-even, Total Contribution Margin = Total Fixed Cost

2.08Q + 6.08 Q = 13,050,000

Q = 13,050,000 / 8.16 = 1,599,264.71 or 1,599,265 pairs.

Running shoe: 1,599,265 x 4/5 = 1,279,412 pairs

Hiking Shoe : 1,599,265 x 1/5 = 319,853 pairs

B. Total fixed costs = $ 12,927,600

	Running Shoe	Hiking Shoe
	$	$
Sales Price	40	66
Variable COGS	13.80	36
Variable Selling and Administrative	23.60	23.60
Contribution Margin	2.60	6.40
Weighted Contribution Margin	2.60 x 1/4 = $ 0.65	6.40 x 3/4 = $ 4.80

Number of shoes required to break-even in the coming year = $ 12,927,600 / ( 0.65 + 4.80) = 2,372,036.70 or 2,372,037 pairs.

Running Shoe:2,372,037 x 1/4 = 593,009 pairs

Hiking Shoe : 2,372,037 x 3/4 = 1,779,028 pairs

C. Before introducing the hiking shoe, break-even point for the firm was = 12,750,000 / 2.60 = 4,903,846 pairs of running shoes.

With the introduction of the hiking shoes, break-even point has fallen to 1,599,265 pairs of shoes.

As there is a fall in the break-even point, the company will be able to start earning profits faster. Therefore, the new type of shoe should be added to the product line.