Data: “I’ll never understand this accounting stuff,” Ricardo Mulliade yelled, wa
ID: 2423513 • Letter: D
Question
Data:
“I’ll never understand this accounting stuff,” Ricardo Mulliade yelled, waving the income statement he had just received from his accountant in the morning mail. “Last month (February), we sold 1,000 stuffed XX Community College mascots and earned $6,850 in operating income. This month (March), when we sold 1,500, I thought we’d make $10,275. But his income statement shows an operating income of $12,100! How can I ever make plans if I can’t predict my income? I’m going to give Binta one last chance to explain this to me,” he declared as he picked up the phone to call Binta Jallow, his accountant.
“Will you try to explain this operating income thing to me one more time?” Ricardo asked Binta. “After I saw last month’s income statement, I thought each mascot we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each mascot, so I don’t understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line.”
Question: Ricardo is evaluating two options to increase the number of mascots sold next month. First, he believes he can increase sales by advertising in the university newspaper. Ricardo can purchase a package of 12 ads over the next month for a total of $1,200. He believes the ads will increase the number of stuffed mascots sold from 500 to 960. A second option would be to reduce the selling price. Ricardo believes a 10% decrease in the price will result in 1,000 mascots sold. Which plan should Ricardo implement (show calculations)? At what level of sales would he be indifferent between the two plans? (Hint: At what sales level would the income from both plans be the same). (10 pts.) _____
Explanation / Answer
From the given question,
Operating income for 1000 units of Mascots sold = $6,850 [ gives $6.85 per unit]
Whereas, Income for 1500 units = $12,100 [ gives $8.07 per unit]
For whatsoever reasons, operating income per unit is increased to $ 8.07 from rise in additional sales of 500 [i.e. 1000 to 1500 sales]
So, Ricardo wants to increase his income further by increasing sales with any of two options below:
a. Increase that additional 500 units to further 960 units by incurring advertisement cost, i.e toal 1960 units (or) b. Increase that additional 500 units to further 1000 units by reducing selling price by 10%, i.e. total 2000 units
Now, Calculation of operating income for option (a):
Sales from 1960 units = 1960 * $8.07 = $15,187
Less: Advertisement cost = $1,200
Operating income = $14,617
Calculation of operating income for option (b):
operating income from 2000 units sold = $ 14,520 [(8.07-10%= 7.26* 2000]
Conclusion: Since, operating income is higher, Ricardo should go for option (a) which means to incur
advertisement cost and increase further sales to 960 units
Calculation of Indifference point for 2 options:
Option A Option B
Variable cost/selling price = $8.07 Variable cost/ selling price = $7.26
Fixed cost [Advertising] = $1,200 Fixed cost = 0
Indifference point = difference in fixed cost/ Difference in variable cost
= [1200-0] / [8.07- 7.26]
= 1200/0.81
= 1482 units
Conclusion: At sales of 1482 units, both options gives same operating profit
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