Question:
Tweed Ltd is a company engaged solely in the manufacture of jumpers, which are bought mainly for sporting activities. Present sales are direct to retailers, but in recent years there has been a steady decline in output because of increased foreign competition. In the-last trading year (2001) the accounting report indicated that the company produced the lowest profit for 10 years. The forecast for 2002 indicates that the present deterioration in profits is likely to continue. The company considers that a profit of £80 000 should be achieved to provide an adequate return on capital. The managing director has asked that a review be made of the present pricing and marketing policies. The marketing director has completed this review, and passes the proposals on to you for evaluation and recommendation, together with the profit and loss account for year ending 31 December 2001.
Tweed Ltd profit and loss account for year ending 31 December 2001
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£
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£
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£
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Sales revenue
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(100 000 jumpers at £10)
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1000000
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Factory cost of goods sold:
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Direct materials
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100000
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Direct labour
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350000
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Variable factory overheads
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60000
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Fixed factory overheads
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220000
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730000
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140000
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Administration overhead
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Selling and distribution overhead_
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Sales commission (2% of sales)
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20000
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Delivery costs (variable per unit sold)
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50000
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Fixed costs
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40000
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110000
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980000
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Profit
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20000
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The information to be submitted to the managing director includes the following three proposals:
(i) To proceed on the basis of analyses of market research studies which indicate that the demand for the jumpers is such that 10% reduction in selling price would increase demand by 40%.
(ii) To proceed with an enquiry that the marketing director has had from a mail order company about the possibility of purchasing 50 000 units annually if the selling price is right. The mail order company would transport the jumpers from Tweed Ltd to its own warehouse, and no sales commission would be paid on these sales by Tweed Ltd. However, if an acceptable price can be negotiated, Tweed Ltd would be expected to contribute £60 000 per annum towards the cost of producing the mail order catalogue. It would also be necessary for Tweed Ltd to provide special additional packaging at a cost of £0.50 per jumper. The marketing director considers that in 2002 the sales from existing business would remain unchanged at 100 000 units, based on a selling price of £10 if the mail order contract is undertaken.
(iii) To proceed on the basis of a view by the marketing director that a 10% price reduction, together with a national advertising campaign costing £30 000 may increase sales to the maximum capacity of 160 000 jumpers.
Required:
(a) The calculation of break-even sales value based on the 2001 accounts.
(b) A financial evaluation of proposal (i) and a calculation of the number of units Tweed Ltd would require to sell at £9 each to earn the target profit of £80 000.
(c) A calculation of the minimum prices that would have to be quoted to the mail order company, first, to ensure that Tweed Ltd would, at least, break even on the mail order contract, secondly, to ensure that the same overall profit is earned as proposal (i) and, thirdly, to ensure that the overall target profit is earned.
(d) A financial evaluation of proposal (iii).
(i) to increase the price of bludgeons by 25%, in the expectation that the price elasticity of demand over this range of prices will be unity;
(ii) to make changes to the production process that would reduce the joint fixed costs by 12.5% and increase the variable costs of each product by 10%;
(iii) 6-introduce both of the above changes.