Problem:
GHI Company makes light-weight canoes for campers. The president, George Ingalls, enlists your help in predicting the effects of some changes he is contemplating. He gives you the following information:
Unit variable costs of each canoe:
Direct materials $ 90
Direct labor 100
Variable factory overhead 20
Variable selling cost 30
Variable administrative cost 10
Annual fixed factory overhead $660,000
Annual fixed selling expenses 190,000
Annual fixed administrative expenses 300,000
Each canoe sells for $400. Demand for the upcoming fiscal year is expected to be 14,400 canoes.
Ingalls is considering the following two alternative actions:
Action 1: Spend $25 on each canoe to strengthen the hull. The engineering design staff believes this action would cause demand to increase 30 percent because the canoe then would be superior to any competing product on the market.
Action 2: Increase advertising by $50,000. The sales manager believes this action would increase demand by 12 percent.
Required:
Compute the expected operating income for the year if no change is made.
Calculate the expected operating income under each proposed change. Use the unit-based "CVP Equation" found in the session 5 materials in the blackboard course documents content area; goal seek is not acceptable for computing these amounts. If the president's objective is to maximize short-term operating income, what should he do? (Select from the two actions above. These are the only actions Ingalls will consider.)
Compute the percentage increase in demand (unit sales) under action 1 that would yield the same operating income as action 2 would yield.
Why might Ingalls implement the alternative action other than the one you recommended in requirement 2? (Hint: use the word "strategy" in your answer.) What would be the short-term cost of taking that alternative action?