Linda and Tom are two friends that formed a partnership which will start operations at the end of 2021. They are going to sell a type of energy drink which is aimed at fitness buffs. For 2022 their condensed budgeted income statement is as follows:

According to their analysis:

  1. 1)  45% of the cost of goods sold is variable (the rest is fixed cost)
  2. 2)  55% of the selling expenses is variable (the rest is fixed cost)
  3. 3)  40% of the administrative expenses is variable (the rest is fixed cost)
  1. 4)  The industry market potential is 12 million households.
  2. 5)  Each household that demands, will buy 5 units per year.
  3. 6)  According to the budgeted income statement Linda and Tom expect to capture a market share of 0.75%.

7)  The average selling price is $4.00 per unit in 2022

 

Questions:

(Round to nearest unit, dollar, and percentage, where necessary. Use the CVP income statement format in calculating profits.)

  1. a)  For 2022 calculate the contribution margin %, contribution margin/unit, break-even point in total sales dollars and in units for Linda and Tom.
  2. b)  As you can see from the budgeted income statement, they are making loss in 2022. Linda has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels that the quality of the product could be substantially improved by spending $0.25 more (VC) per unit on better raw materials. The selling price per unit could be increased to only $5.00 because of competitive pressures. Linda estimates that market share will increase to 1%.

What effect would Linda’s plan have on the partnership’s profits and its break-even point in

dollars & in units?

  1. c)  Tom was a marketing major in university. He believes that the market share can be increased only by intensive advertising and promotional campaigns. He therefore proposed the following plan as an alternative to Linda’s:

(1) increase the variable selling costs which will then increase the total variable unit cost to $3.00

(2) increase the selling price per unit to $5.25, and
(3) increase fixed selling expenses by $75,000.
Tom also quoted a marketing research report that says market share would increase by 0.50% if these changes were made (According to Tom new market share will be 1.25% after intensive advertising and promotional campaigns).
What effect would Tom’s plan have on the partnership’s profits and its break-even point in dollars & in units?

  1. d)  Determine which plan should be accepted. Explain your answer.

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