Exercises in Financial Analysis and Marketing Decision Making 1

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: clarkeix@jmu.edu
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