Purple Cow operates a chain of drive-ins selling primarily ice cream products. T
ID: 2419468 • Letter: P
Question
Purple Cow operates a chain of drive-ins selling primarily ice cream products. The following infor-
mation is taken from the records of a typical drive-in now operated by the company:
Average selling price of ice cream per gallon= 14,80
Number o gallons sold per month= 3,000
Variable costs per gallon:
Ice cream= 4,60
Supplies (cups, cones, toppings, etc.)= 2.20
Total variable expenses per gallon= 6,80 . . . .
Fixed costs per month:
Rent on building 2,200
Utilities and upkeep= 760
Wages, including payroll taxes = 4,840
Manager’s salary, including payroll taxes but
excluding any bonus = 2,500
Other fixed expenses = 1,700
Total fixed costs per month: 12,000
Based on these data, the monthly break-even sales volume is determined as follows:
$12,000 (fixed costs)/$ 8.00( contribution margin per unit)= 1,500 gallons (or $22,200)
Instructions
a. Currently, all store managers have contracts calling for a bonus of 20 cents per gallon for each gallon sold beyond the break-even point. Compute the number of gallons of ice cream that must be sold per month in order to earn a monthly operating income of $10,000 (round to the nearest gallon).
b. To increase operating income, the company is considering the following two alternatives:
1. Reduce the selling price by an average of $2.00 per gallon. This action is expected to increase the number of gallons sold by 20 percent. (Under this plan, the manager would be paid a salary of $2,500 per month without a bonus.)
2. Spend $3,000 per month on advertising without any change in selling price. This action is expected to increase the number of gallons sold by 10 percent. (Under this plan, the manager would be paid a salary of $2,500 per month without a bonus.)
Which of these two alternatives would result in the higher monthly operating income? How many gallons must be sold per month under each alternative for a typical outlet to break even? Provide schedules in support of your answers.
c. Draft a memo to management indicating your recommendations with respect to these alterna- tive marketing strategies.
Explanation / Answer
a. Computation of no. of gallons to earn income of $10000
= (FIXED COST + DESIRED INCOME ) / CONTRIBUTION MARGIN PER UNIT
= (12000 + 10000) / 8
= 2750 GALLONS
b. 1) CONTRIBUTION PER UNIT = SELLING PRICE PER UNIT - REDUCTION - VARIABLE COST
= 14.8 - 2 - 6.8
= $6 PER GALLON
BREAK-EVEN(UNITS) = FIXED COST / CONTRIBUTION PER UNIT
= 12000 / 6
= 2000 GALLONS
INCREASE IN NUMBER OF SALES = 3000+20%
= 3600 GALLONS
INCOME STATEMENT
SALES REVENUE = 46080 (3600*12.8)
(-)VARIABLE COST = (24480) (3600*6.8)
(-)FIXED COST = (12000)
PROFITS = $9600
2)INCREASE IN FIXED COST DUE TO ADVERTISEMENT = 12000+3000
= $15000
INCREASE IN NUMBER OF SALES = 3000+10%
= 3300 GALLONS
BREAK EVEN = 15000/8
= 1875 GALLONS
INCOME STATEMENT
SALES REVENUE = 48840 (3300*14.8)
(-)VARIABLE COST = (22440) (3300*6.8)
(-) FIXED COST = (15000)
PROFITS = $11400
c . As per my recommendation Purple Cow should opt for 2nd option having more income($11400) than 1st option($9600).Thus Purple Cow should advertise its products to increase its income.
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