Question:
Universal Sports Exchange has just received notice from C&C Sports that the cost of a baseball jersey will be increasing to $15.30 next year. In response to this increase, Universal is planning its sales and marketing campaign for the coming year. Managers have developed two possible plans and have asked you to evaluate them. The first plan calls for passing on the entire $0.50 cost increase to customers through an increase in the sales price. Managers believe that $5,000 in additional advertising targeted directly to current customers will allow the sales force to reach the current year"s sales volume of 52,500 jerseys. The second plan relies on a new advertising campaign that focuses on the sales price remaining the same as last year. The campaign would include a new database that offers more potential customers than Universal has had access to in the past. The cost of the campaign is expected to be $10,000. Managers believe that the campaign will be more successful in generating new sales than the current incentive-based sales and marketing plan. As a result, they want to reduce the sales commission from 6% to 4% of sales and increase sales salaries by $22,000. The campaign is expected to generate an additional 10% in sales volume. Using the information as a starting point, complete the following questions.
Required
1. How much would operating income decrease if Universal did nothing to recover the increase in cost of goods sold, all other things equal?
2. Determine the expected operating income under each proposed sales and marketing plan.
3. Why does the first plan result in a reduction in operating income that is greater than the $5,000 advertising?
4. Which plan do you recommend to management? Why?