Question

Your regular price is $30/unit, unit variable cost is $20/unit and fixed costs are $3,000 per month. Because of the recession, your sales have dropped to 200 units a month, so you are losing money. You are considering two options to increase sales:
(1) reduce the price to $28/unit, or
(2) run an advertising campaign, which will cost you $300 a month, but keep the price at $30/unit.
In both scenarios, you estimate that sales will increase by 20%, from 200 to 240 units per month.

Required:

a) Compute total revenues, costs and profits under the status quo (original situation), and for each of the two new options.

b) Based on your results in (a), what should you do: do nothing, reduce the price or run the advertising campaign?
(enter 1 for "do nothing", 2 for "reduce price", 3 for "advertising")

c) If you solved (a) and (b) correctly, you are still losing money despite choosing the best option. Should you shut down your business in the short term? Explain why or why not.

Answer 1

Answer:

Answer is in table which is attached in the attachment. Please refer to the attachment.

Explanation:

Calculations:

Status quo: Revenue 30* 200= 6000, VC 30*20= 4000, CM 6000-4000= 2000, 2000-3000= -1000 (Contribution Margin – fixed cost = Profit/Loss)

(b) Since the loss is less in Advertising even after $300 cost of advertisement, so we would choose the option 3 for advertising.

(c). In order to survive in the period of recession, a business needs cash and reducing operation expenses can do it better. This business is in loss from last three months so it might be useful to shut down the business for some period.