The sales manager is convinced that a 11% reduction in the selling price, combined with a $70,000 increase in advertising, would increase this year's unit sales by 25%. a. If the sales manager is right, what would be this year's net operating income if his ideas are implemented? b. Do you recommend implementing the sales manager's suggestions?

Question:

Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $80 per unit. Variable expenses are $40.00 per unit, fixed expenses total $200,000 per year. Its operating results for last year were as follows:

Sales $2,160,000

Variable expenses $1,080,000

Contribution margin $1,080,000

Fixed expenses $200,000

Net operating income $ 880,000

Answer:

As the net profit is $783,000 which is lower than $880,000, my advice would be that this strategy must not be implemented because doesn't brings value to the company.

Explanation:

The contribution per unit is:

Contribution per unit = Selling price per unit - variable cost per unit

Contribution per unit = $80*89% - $40 = $31.2 per unit

The increase in advertisement expense can be calculated under the new condition by the following formula:

New Sales ($) = (Fixed cost + Profit) * Sales Prices per unit / Contribution Per unit

Here we have total fixed cost of $270,000 by including the $70000 increase in advertising cost.

By putting values we have:

$2,160,000 * 125% = ($270,000 + Profit) * $80 per unit / $38.3 per unit

$2,700,000 * 31.2 / 80 = $270,000 + Profit

$1,053,000 - $270,000 = Profit

Profit = $783,000