Exercises in Financial Analysis and Marketing Decision Making 1 Overview Problem Number and Title Financial Analyses Performed for Marketing Decision Making Slides 1 - Studio Recordings Inc. Break-even analysis calculations; determination of fixed and variable cost; profit impact analysis. 3-6 2 - Video Concepts Inc. (A) Distinctions among investment, fixed, and variable costs in the context of calculating contribution margins, breakeven points, and market share requirements. 7-9 3 - American Therapeutic Corp. Basic calculations involved with incrementalism and the implications of the concept. 10-13 4 - Diversified Citrus Industries Trade margins; determination of variable costs, break-even analysis as it relates to relevant and sunk costs; break-even share of market. 14-17 5 - Video Concepts Inc. (B) Product cannibalism and the importance of focusing on the contribution of a product-line addition to fixed costs rather than simply its incremental sales. 18-19 6 - Dysk Computer Inc. Cannibalism analysis when a new product is being added to the product line. 20-22 8 - Century Office Systems, Inc. Preparation of a pro forma income statement; consideration of changes in net profit before taxes assuming projected sales do not materialize; further application of break-even analysis. 24-26 2 PROBLEM 1: STUDIO RECORDINGS INC. 1. Calculate the contribution per CD unit Selling price to CD distributor $9.00 Less: Variable costs CD Package and disk (direct material/labor) Songwriter’s royalties Recording artists’ royalties $1.25/unit $0.35/unit $1.00/unit Total variable costs $2.60 Contribution per CD unit $6.40 3 PROBLEM 1: STUDIO RECORDINGS INC. 2. Calculate the break-even volume in CD units and dollars Total Fixed Cost: Adv. & Promo Studio Recordings Inc. Overhead Total Contribution per CD unit (from #1 above) $275,000 250,000 $525,000 $6.40 Contribution margin ($9.00 - $2.60)/$9.00 = .711 or 71.1% Break-even volume in units = $525,000 = 82,031 units $6.40 Break-even volume in dollars = $525,000 = $738,396.62 .711 = 82,031.25 x $9.00 = $738,281.25 (difference is due to rounding the contribution margin percent) 4 PROBLEM 1: STUDIO RECORDINGS INC. 3. Calculate the net profit if 1 million CDs are sold Less: Less: Total Sales (1,000,000 units x $9.00) Total Variable Cost (1,000,000 units x $2.60) Total Fixed Cost Net Profit $9,000,000 2,600,000 525,000 $5,875,000 5 PROBLEM 1: STUDIO RECORDINGS INC. 4. Calculate the necessary CD unit volume to achieve a $200,000 profit Profit objective Fixed cost Contribution per Unit = = = $525,000 Fixed Cost + $200,000 Profit Objective $6.40 Contribution per Unit $200,000 $525,000 $6.40 = 113,281.25 units 6 PROBLEM 2: VIDEO CONCEPTS, INC. (A) 1. What is VCI’s unit contribution and contribution margin? Selling price for VCI: $20.00 Suggested Retail Price -8.00 Retailer Margin (40% of suggested retail price) $12.00 Variable cost per unit Copy Reproduction ($4,000/1000) Label & Packaging Mfg. ($500/1000) Royalties ($500/1000) Total variable cost per unit $4.00 .50 .50 $5.00 Unit contribution = $12.00 - $5.00 = $7.00 Contribution margin = $7.00 = .583 or 58.3% $12.00 7 PROBLEM 2: VIDEO CONCEPTS, INC. (A) 2. What is the breakeven point in units? In dollars? Fixed Costs: Distribution rights for film Label design Advertising Package design $125,000 5,000 35,000 10,000 $175,000 Breakeven points in units = $175,000 = 25,000 units $7.00 Breakeven points in dollars = $175,000 = $300,172 .583 8 PROBLEM 2: VIDEO CONCEPTS, INC. (A) 3. What share of the market would the film have to achieve to earn a 20% return on VCI’s investment the first year? 20 percent return first year $150,000 (investment) x .20 = $30,000 Fixed cost plus required return $175,000 + $30,000 = $205,000 Units required to achieve return $205,000 = 29,286 units $7.00 Market share required 29,286 (B/E Unit Volume) = .293 or 29.3% 100,000 (Est. Mkt. Size) 9 PROBLEM 3: AMERICAN THERAPEUTIC CORPORATION 1. What absolute increase in unit sales and dollar sales will be necessary to recoup the incremental increase in advertising expenditures for Rash-Away? Red-Away? Rash-Away: Contribution Margin = $2.00 - $1.40 = 30% $2.00 Absolute Increase in Unit Sales = $150,000 = 250,000 units $.60 Absolute Increase in Dollar Sales = $150,000 = $500,000 .30 Red-Away: Contribution Margin = $1,00 - $.25 = 75% $1.00 Absolute Increase in Unit Sales = $150,000 = 200,000 units $.75 Absolute Increase in Dollar Sales = $150,000 = $200,000 .75 10 PROBLEM 3: AMERICAN THERAPEUTIC CORPORATION 2. How many additional sales dollars must be produced to cover each $1.00 of incremental advertising for Rash-Away? Red-Away? Rash-Away: $1.00 incremental advertising = $3.33 30% contribution margin Sales Variable Costs (70%) Contribution Margin (30%) Incremental Fixed Cost Profit Red-Away: $3.33 2.33 $1.00 1.00 0 $1.00 incremental advertising = $1.33 75% contribution margin Sales Variable Costs (25%) Contribution Margin (75%) Incremental Fixed Cost Profit $1.33 .33 $1.00 1.00 0 11 PROBLEM 3: AMERICAN THERAPEUTIC CORPORATION 3. What increase in absolute unit sales and dollar sales will be necessary to maintain the level of total contribution dollars if the price for each product is reduced by 10 percent? Rash-Away: Current Contribution Dollars = 1,000,000 units x $.60 = $600,000 New Price and Contribution with 10% Price Reduction = $1.80 Unit Price 1.40 Unit Variable Costs $.40 Unit Contribution or 22.22% Contribution Margin ($.40/$1.80) $.40(x) = $600,000 , where x = units x = 1,500,000 units Increase in Unit Sales = 500,000 (1,500,000 – 1,000,000 = 500,000) .2222(x) = $600,000, where x = dollars x = $2,700,000 (rounded since contribution margin is actually 22.2222%) Increase in Dollar Sales = $700,000 ($2,700,000 - $2,000,000) 12 Continued on next slide Continued Red-Away: Current Contribution Dollars = 1,500,000 units x $.75 = $1,125,000 New Price and Contribution with 10% Price Reduction = $.90 Unit Price .25 Unit Variable Costs $.65 Unit Contribution or 72.22% Contribution Margin ($.65/$.90) $.65(x) = $1,125,000 , where x = units x = 1,730,769 units Increase in Unit Sales = 230,769 (1,730,769 – 1,5000,000 = 230,769) .7222(x) = $1,125,000, where x = dollars x = $1,557,6920 (rounded since contribution margin is actually 72.2222%) Increase in Dollar Sales = $57,692 ($1,557,692 - $1,500,000) 13 PROBLEM 4: DIVERSIFIED CITRUS INDUSTRIES 1. At what price will Diversified Citrus Industries be selling their product to wholesalers? Retail Price to Consumer 50 ¢ -20% margin (10 ¢) Retail Cost/Wholesaler Price 40 ¢ -10% margin (4 ¢) Wholesaler Cost/Manufacturer Price 36 ¢ 14 PROBLEM 4: DIVERSIFIED CITRUS INDUSTRIES 2. What is the contribution per unit for ZAP? Unit selling price = Unit Variable Costs: Material Labor Coupon (1/5 x 20 ¢ = 4 ¢) $0.36 $.18 .06 .04 Contribution per unit = .28 $.08 15 PROBLEM 4: DIVERSIFIED CITRUS INDUSTRIES 3. What is the break-even unit volume in the first year? Total Fixed Costs: Advertising Overhead $250,000 90,000 $340,000 Contribution per unit $.08 Break-even Unit Volume = $340,000 = 4,250,000 $.08 16 PROBLEM 4: DIVERSIFIED CITRUS INDUSTRIES 4. What is the first year break-even share-ofmarket? Total U.S. Market Size = 21 million 8-oz. cans Market Served by Marketing Program = 65% of U.S. Therefore, .65 x 21 million = 13,650,000 8-0z. Cans First year break-even share-of-market is: Break-even Unit Volume Market Served Size = 4,250,000 = .31 or 31% 13,650,000 17 PROBLEM 5: VIDEO CONCEPTS, INC. (B) 1. Should VCI add new Model LXR to its line of VCRs? Why? Present product line contribution Product LX1 LX2 LX3 Selling Price $175 $250 $300 Unit Variable Cost $100 $125 $140 Total Units Sold 2,000 1,000 500 3,500 Contribution $150,000 125,000 80,000 $355,000 Note: LX1 present contribution is ($175-100) x 2,000 = $150,000 If LX4 is added to the present product line, it will cannibalize the sales of the present product line as shown below: Total product sales of LX4 Cannibalized sales (60%) From LX1 (10%) From LX2 (30%) From LX3 (60%) Incremental Sales (40%) 300 units 180 units 18 units 54 units 108 units 120 units 18 Continued on next slide Continued Product contribution if LX4 added LX1 LX2 LX3 ($175 - $100) x 1982 = $148,650 ($250 - $125) x 946 = 118,250 ($300 - $140) x 392 = 62,720 $329,620 LX4 ($375 - $225) x 300 = $45,000 Total product line contribution $374,620 The addition of the LX4 model does increase product line contribution by $19,620 (Original contribution = $355,000 vs. New contribution = $374,620). However, VCI will incur an incremental fixed cost of $20,000 to add the LX4 model to the line. Therefore, VCI incurs a loss of $380: $19,620 - $20,000 = -$380. The decision? Do not introduce LX4 because incremental contribution does not cover incremental fixed cost. 19 PROBLEM 6: DYSK COMPUTER, INC. 1. Should Mr. Leonard add the DC6900-X model to the line? This problem can be approached in two ways. Approach 1. Given: Unit Selling Price - DC6900-Omega $5,900 - DC6900-Alpha $2,500 DC6900-X $3,900 Product Unit Variable Cost = Unit Contribution $2,200 = $3,700 - $1,200 = $1,300 - $1,800 = $2,100 Fixed cost for introducing the CD6900-X in the First Year = $2,000,000 20 Continued on next slide continued Therefore: a. b. c. d. e. f. The DC6900 line will lose $1,600 in unit contribution each time a sale is diverted away from the DC6900-Omega to the DC6900-X. This occurs because the DC6900-X contribution is $2,100 and the DC6900-Omega contribution is $3,700. The DC6900 line will gain $800 in unit contribution each time a sale is diverted away from the DC 6900-Alpha to the DC6900-X. This occurs because the DC6900-X contribution is $2,100 and the DC6900-Alpha contribution is $1,300. Given that the problem states that 30% of the DC6900-X sales (.3 x 500 units), or 150,000 units will be cannibalized from the DC6900-Omega, the total contribution lost will be $1,600 x 150,000 units = $240,000,000. Given that the problem states that 20% of the DC6900-X sales (.2 x 500,000 units), or 100,000 units will be cannibalized from the DC6900-Alpha, the total contribution gained will be $800 x 100,000 units = $80,000,000. Given that the problem states that the DC6900-X will sell an additional 250,000 units at a $2,100 unit contribution, then incremental net new volume will be $2,100 x 250,000 = $525,000,000. The net financial effect of the DC6900-X will be: Net New Volume + Gain from DC6900-Alpha - Loss Due to Cannibalization from DC6900-Omega - Less Fixed Cost of Introduction $525,000,000 80,000,000 $605,000,000 240,000,000 2,000,000 + $363,000,000 21 Continued on next slide Continued Approach 2. Product DC6900-Alpha DC6900-Omega Next Year Unit Volume Unit Contribution Contribution Dollars 500,000 250,000 750,000 $1,300 $3,700 $650,000,000 $925,000,000 $1,575,000,000 250,000 250,000 1,250,000 $2,100 $2,100 $525,000,000 $525,000,000 $1,050,000,000 $1,300 $3,700 $780,000,000 $1,480,000,000 $2,260,000,000 +DC6900-X Cannibalized Vol. Incremental Vol. Less Original Forecast For: DC6900-Alpha 600,000 DC6900-Omega 400,000 1,000,000 Less Fixed Costs $2,000,000 $363,000,000 In summary Dsyk should add the DC6900-X model as it will make a $363 million profit before tax. 22 Note to Students: Do not do problem #7. 23 PROBLEM 9: CENTURY OFFICE SYSTEMS, INC. 1. Prepare a pro forma income statement for the Home Office Systems Group given the information provided. Sales Cost of Goods Sold Gross Margin Marketing Expenses Sales Expenses Advertising/Sales Promotion Expenses Freight Expenses General and Administrative Expenses Administrative Overhead Manufacturing Overhead Staff Salaries & Benefits Net Profit Before (Income) Tax $25,000,000 12,500,000 12,500,000 $6,750,000 1,650,000 2,000,000 $300,000 600,000 250,000 10,400,000 1,150,000 $950,000 24 PROBLEM 9: CENTURY OFFICE SYSTEMS, INC. 2. Prepared a pro forma income statement for the Home Office Systems group if annual sales of only $20 million materialize. Sales Cost of Goods Sold Gross Margin Marketing Expenses Sales Expenses Advertising/Sales Promotion Expenses Freight Expenses General and Administrative Expenses Administrative Overhead Manufacturing Overhead Staff Salaries & Benefits Net Profit Before (Income) Tax $20,000,000 10,000,000 10,000,000 $6,000,000 1,400,000 1,600,000 $300,000 600,000 250,000 9,000,000 1,150,000 ($150,000) 25 PROBLEM 9: CENTURY OFFICE SYSTEMS, INC. 3. At what level of dollar sales will the Home Office Systems group break-even. Sales Cost of Goods Sold Gross Margin Marketing Expenses Sales Expenses Advertising/Sales Promotion Expenses Freight Expenses General and Administrative Expenses Administrative Overhead Manufacturing Overhead Staff Salaries & Benefits Net Profit Before (Income) Tax $20,681,818 10,340,909 10,340,909 $6,102,272.90 1,434,090.90 1,654,545.40 $300,000 600,000 250,000 9,190,909 1,150,000 $0 26 Questions or Comments? Dr. Irvine Clarke III Professor of Marketing James Madison University College of Business Marketing Program MSC 0206 Harrisonburg, VA 22807 Phone: 540-568-3049 e-mail: [email protected] 27 Copyright  All Rights Reserved Copyright  2014 by Irvine Clarke III, Ph.D. No part of these materials may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without the express written consent of Dr. Irvine Clarke III. 28
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