Data: “I’ll never understand this accounting stuff,” Ricardo Mulliade yelled, wa
ID: 2423428 • Letter: D
Question
Data:
“I’ll never understand this accounting stuff,” Ricardo Mulliade yelled, waving the income statement he had just received from his accountant in the morning mail. “Last month (February), we sold 1,000 stuffed mascots and earned $6,850 in operating income. This month (March), when we sold 1,500, I thought we’d make $10,275. But his income statement shows an operating income of $12,100! How can I ever make plans if I can’t predict my income? I’m going to give Binta one last chance to explain this to me,” he declared as he picked up the phone to call Binta Jallow, his accountant.
“Will you try to explain this operating income thing to me one more time?” Ricardo asked Binta. “After I saw last month’s income statement, I thought each mascot we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each mascot, so I don’t understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line.”
REQUIRED:
1) Ricardo is evaluating two options to increase the number of mascots sold next month. First, he believes he can increase sales by advertising in the university newspaper. Ricardo can purchase a package of 12 ads over the next month for a total of $1,200. He believes the ads will increase the number of stuffed mascots sold from 500 to 960. A second option would be to reduce the selling price. Ricardo believes a 10% decrease in the price will result in 1,000 mascots sold. Which plan should Ricardo implement (show calculations)? At what level of sales would he be indifferent between the two plans? (Hint: At what sales level would the income from both plans be the same).
2) Just after Ricardo completed an income projection for 1,200 stuffed mascots, his supplier called to inform him of a 20% increase in cost of goods sold (an increase from $10.00 per unit to $12.00 per unit), effective immediately. Ricardo knows that he cannot pass the entire increase on to his customers, but thinks he can pass on half of it while suffering only a 5% decrease in units sold. Should Ricardo respond to the increase in cost of goods sold with an increase in price? (Hint: Prepare two income statements; one with no increase in sales price and the other with the increase).
Explanation / Answer
1. per unit operating income after 1,000 units = $12,100 - $6,850/ 1,500-1,000
= 5,250/500 = $10.5
If cost of goods sold is $10 then price of goods sold = $10 + $10.5 = $20.5
fixed cost = ($20.5 -$10) *1,000 - $6850 = $ 3,650
first option second option
Sales (1,960*20.5 units)$40,180 (2,000*18.45units) $36,900
Cogs 1,960 *$10 $19,600 2,000* $10 $20,000
Fixed cost($3,650+$1,200)$4,850 $3,650
Operating income $15,730 $13,250
So first option is good as it has more operating income.
2. first option increase in cost of goods sold but no increase in sale price
second option increase in cost of goods sold and increase in sale price by 20% increase in COGS
first option second option
Sales (1,200*20.5 units) $24,600 (1,140*21.5units) $24,510
Cogs 1,200 *$12 $14,400 1,140* $12 $13,680
Fixed cost($3,650) $3,650 $3,650
Operating income $6,550 $7,180
Yes Ricardo should respond with increase in price to increase in cost of goods sold.
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