Sensitivity and inflation (continuation of Exercise 8.24) (10-20 minutes) As cha
ID: 2409849 • Letter: S
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Sensitivity and inflation (continuation of Exercise 8.24) (10-20 minutes) As chairman of Walk-About, you are concerned that inflation may squeeze your profitability Specifically, you feel committed to the £30 selling price, and fear that lowering the quality of the shoes in the face of rising costs would be an unwise marketing move. You expect the cost of shoes to rise by 10% during the coming year. You are tempted to avoid the cost increase by placing a non-cancellable order with a large supplier that would provide 50 000 units of the specified quality for each store at £19.50 per unit. (To simplify this analysis, assume that all stores will face identical demands.) These shoes could be acquired and paid for as delivered throughout the year However, all shoes must be delivered to the stores by the end of the year. As a shrewd merchandiser, you foresee some risks. If sales were less than 50 000 units, you feel that markdowns of the unsold merchandise would be necessary to sell the goods. You predict that the average selling price of the leftover units would be £18.00. The regular commission 5% of revenues would be paid to salespeople. Required 1 Suppose that actual sales at £30 for the year are 48 000 units and that you contracted for 8.26 50 000 units. What is the operating profit for the store? 50 000 units. What would the operating profit have been if you had ordered 48 000 units? rise before you would have been indifferent between having the contract for 50 000 units and 2 If you had perfect forecasting ability, you would have contracted for 48 000 units rather than 3 Given actual sales of 48 000 units, by how much would the average cost per unit have had not having the contract?Explanation / Answer
1. Revenue when sales price is £30 and 48000 units are sold.
Revenue = 48000 * 30 + Leftover 2000 * 18 = £1440000 + 36000 = £1476000
Expenses = COGS will be 50000 @ £19.50 + 5% commision of £1,476,000 = 975000 + 73800 = £1,048,800
Operating Profit = Revenue - COGS - Commision = 1476000 - 975000 - 73800 = £426,200
2. If we contract only for 48000 units then,
Revenue = 48000 @ £30 = £1,440,000
Expenses = COGS will be 48000 @ £19.50 + 5% commision of £1,440,000 = 936000 + 72000 = £1,008,000
Operating Profit = Revenue - COGS - Commision = 1440000 - 936000 - 72000 = £432,000
3. We are expecting a rise of around 10%, so if the supplier quotes us a price of £19.50 + 10% of 19.50, which will be 19.50 + 1.95 = £21.45. So at a cost price of £21.45 or more we will not be interested in any contract. Any price below this level can be accepted.
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