Your company’s sales are 50,000 units. The unit variable cost is $12. Your markup percent on sales is 40% and your fixed costs are $100,000.
1. What is your profit / loss? $100,000
You are thinking of increasing your advertising by $200,000. Based on previous data, you know that for every dollar increase in advertising your sales will go up by $2.
2. Should they go for it or not?
To determine whether they should go for the increase in advertising or not, we need to calculate the impact of the increase on sales and the resulting change in profit/loss.
1. Calculate the current profit/loss:
Profit/Loss = (Sales - Variable Costs) - Fixed Costs
Sales = 50,000 units
Unit Variable Cost = $12
Fixed Costs = $100,000
Markup Percentage = 40%
First, let's calculate the selling price per unit:
Selling Price = Unit Variable Cost / (1 - Markup Percentage)
Selling Price = $12 / (1 - 0.4)
Selling Price = $12 / 0.6
Selling Price = $20
Total Sales = Sales * Selling Price
Total Sales = 50,000 units * $20
Total Sales = $1,000,000
Total Variable Costs = Unit Variable Cost * Sales
Total Variable Costs = $12 * 50,000 units
Total Variable Costs = $600,000
Profit/Loss = (Total Sales - Total Variable Costs) - Fixed Costs
Profit/Loss = ($1,000,000 - $600,000) - $100,000
Profit/Loss = $400,000 - $100,000
Profit/Loss = $300,000
Therefore, the current profit is $300,000.
2. Calculate the impact of the increase in advertising on sales:
Sales Increase per Dollar Increase in Advertising = $2
Based on previous data, for every dollar increase in advertising, sales will go up by $2. So, if they increase advertising by $200,000, we can calculate the corresponding increase in sales:
Sales Increase = Sales Increase per Dollar Increase in Advertising * Advertising Increase
Sales Increase = $2 * $200,000
Sales Increase = $400,000
3. Calculate the new profit/loss after the increase in advertising:
New Total Sales = Total Sales + Sales Increase
New Total Sales = $1,000,000 + $400,000
New Total Sales = $1,400,000
New Profit/Loss = (New Total Sales - Total Variable Costs) - Fixed Costs
New Profit/Loss = ($1,400,000 - $600,000) - $100,000
New Profit/Loss = $800,000 - $100,000
New Profit/Loss = $700,000
Conclusion: After the increase in advertising, the new profit would be $700,000.
Based on this analysis, they should go for the increase in advertising because it is expected to result in a higher profit ($700,000) compared to the current profit ($300,000).