This essay is a case study of Hi-Lo Company. The company produces a product called herbal candy, which is sold in its major market segments. The company is reported to be selling 600,000 products on a monthly basis. Besides, there is some other financial information relating to the company: the sales revenue equals to $ 600,000; and the variable cost is $ 180,000. The fixed costs consist of salary ($ 50,000), rent on building ($ 32,000), advertising ($ 100,000), depreciation on equipment ($ 32,000) and other costs ($ 66,000). The main task is to prove whether the marketing manager is right by suggesting that an increase of $ 10,000 in the advertisement expense would lead to a 10% increase in sales. The second task is to recommend the implementation of a new production process, and the last task is to assess how the proposed changes would influence the company’s break-even point, the new margin of safety and the net profit.
Increase in the Advertising Expense
The company’s fixed cost would increase to $ 290,000, if the advertising costs were raised by $ 10,000. The increase in the fixed cost would increase the company’s break-even level, because the fixed cost is an element of the break-even model. The 10% increase in the sales level due to the proposed advertising expense would generate the sales revenue worth $ 60,000. Therefore, the total amount of revenue that would be generated on a monthly basis is $ 660,000. The financial records of the company would reflect the sales revenue of $ 660,000 and a total cost of $470,000. From the two figures, it is obvious that the company’s profit would be $190,000 compared to $ 140,000 (with no increase in advertisement expense). Mathematically speaking, the Vice President is right about his proposal and, therefore, I would recommend the implementation of his proposal.
Change in the Production Process
The current variable cost per bottle is $ 0.3 giving a total of $ 180,000 for all the 600,000 bottles. A decrease in variable cost by $ 0.05 would reduce the variable cost to (0.3-0.05) = $ 0.25 per bottle. Therefore, the new total variable costs would be (0.25*600,000) = $ 150,000. The total fixed cost of the company would be (150,000+300,000) = $450,000. The net profit of the company would be $150,000 as compared to $140,000. The change would increase the level of the profit and, therefore, I would recommend its implementation.
The New Break-Even Sales
The bottles cost $ 1 each and the new variable cost per bottle would be (150,000/660,000) = $ 0.227. If the changes in parts 7 and 8 were both implemented, the new break-even point in sales would be = 582,148 bottles. The BEP in sales would be $ 582,148.
The New Margin of Safety
The expected sales level is 660,000 and the BEP is 582,148 bottles. Therefore, the margin of safety is (660,000-582148) /660,000 = 11.8%. The value net profit, when sales were 600,000 bottles, would be (600,000-450,000) = $150,000.