3. Hau Lee Furniture, Inc., spends 60% of its sales dollars in the supply chain

Question

3. Hau Lee Furniture, Inc., spends 60% of its sales dollars in the supply chain and has a current gross profit of $10,000. Hau wishes to increase gross profit by $5,000 (50%). He would like to compare two strategies: reducing material costs vs. increasing sales. The current material costs and production costs are 60% and 20%, respectively, of sales dollars, with fixed cost at a constant $10,000. Analysis indicates that an improvement in the supply chain that would reduce material costs by 8.3% ($5,000/$60,000) would produce a 50% net profit gain for Hau, whereas a much larger 25% increase in sales ($25,000/$100,000) would be required to produce the same result. Now Hau finds its current profit of $10,000 inadequate. The bank is insisting on an improved profit picture prior to approval of a loan for some new equipment. Hau would like to improve the profit line to $25,000 so he can obtain the bank’s approval for the loan

What percentage improvement is needed in the supply chain strategy for profit to improve to $25,000? What is the cost of material with a $25,000 profit?

What percentage improvement is needed in the sales strategy for profit to improve to $25,000? What must sales be for profit to improve to $25,000?

Explanation / Answer

1) The material costs and production costs are 60% and 20% of sales and fixed cost is constant at $ 10000. Therefore, gross profit = (1-0.6-0.2)*Sales-10000 = 0.2*Sales - 10000 = 10000

Therefore, sales = 20000/20% = $ 100,000

Improvement needed in gross profit = 25000-10000 = $ 15000

Dollar improvement needed in supply chain strategy = $ 15000

Percentage improvement needed in supply chain strategy = 15000/60000 = 25 %

Cost of material with a $ 25000 profit = 60000*(1-25%) = $ 45,000

2) Gross profit = Sales*(1-0.6-0.2)-1000 = 0.2*Sales - 10000

Desired gross profit = 25000

Therefore, 0.2*Sales - 10000 = 25000

Sales = 35000/0.2 = 175000

Dollar improvement needed in sales strategy = 175000 - 100000 = 75000

Percentage improvement needed in sales strategy = 75000/100000 = 75 %

Sales must be = $ 175,000

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