Cost Volume Profit Analysis Case
Grace's Chocolates Company
You are a consultant with Cox Consultancy. You have a client, Grace that has hired you to advise her on some production decisions relating to her chocolate business and compensation schemes relating to her ice-cream maker business.
Grace's Chocolate Company (GCC) is a very small scale producer of fine chocolates located in central Connecticut which operates primarily around the Holiday season. GCC also sells home ice cream makers all year round.
Assume the following information about the cholate business
Grace's entire annual production takes place over a single weekend in early December, during which a maximum of 3,000 chocolates can be produced and packaged into boxes of thirty chocolates each. For purposes of this problem, assume that all chocolates have identical costs.
Currently, Grace produces 2,400 chocolates during the weekend. Variable costs consist of chocolate and boxes. The cost of other direct materials (such as peanut butter, oils, nonpareils, etc., are considered insignificant, and thus ignored). All other costs, including facilities, overhead, and labor, are considered fixed costs. Each box can be sold for $4. Ignore taxes throughout the problem.
Cost to produce 2,400 chocolates
Variable Costs 32 pounds of chocolate @ $5/pound $160
80 boxes @ $0.50/box 40
Fixed Costs 200
Total Cost $400
Over the past several years, Grace has received numerous customer requests for specialized boxes, containing only a single type of chocolate (Grace's peanut butter cups are especially popular). Grace is therefore considering offering specialized boxes as a new product line. While the chocolates themselves would be the same as before, they would be packaged in a smaller box, costing $0.20 each. The smaller box would hold twelve chocolates, and be sold for $2 per box. Adding the new product line would have no effect on existing costs, including the fixed costs.
GCC also sells two models of home ice cream makers, Mister Ice Cream and Cold King. Current sales total 60,000 units, consisting of 21,000 Mister Ice Cream units and 39,000 Cold King units. Selling price and variable cost information follows.
Mister Ice Cream Cold King Selling price ............................................................. $ 37.00 $ 43.00
Variable cost ............................................................. 20.50 32.50
Salespeople currently receive flat salaries that total $ 200,000. Grace is contemplating a change to a compensation plan that is based on commissions in an effort to boost the company's presence in the marketplace.
Two plans are under consideration:
Plan A: 10% commission computed on gross dollar sales. Mister Ice Cream sales are anticipated to be 19,500 units. Cold King sales are expected to total 45,500 units.
Plan B: 30% commission computed on the basis of production contribution margins. Mister Ice Cream sales are expected to total 39,000 units. Cold King sales are anticipated to be 26,000 units.
Grace is contemplating various decisions relating to her two business and needs your expert advice. Consider the two businesses independent of each other.
Chocolate business
1. What is GCC's breakeven point (in number of boxes)? Hint: It is not feasible.
2. Assuming that GCC completely shifted over to producing specialty boxes, and that they produced as many as possible, how much profit would GCC earn?
3. If GCC were to produce a mixture of both regular and specialty boxes, what is the smallest number of specialty boxes which would need to be produced in order to break-even? Assume that total production is at the maximum of 3,000 chocolates, and that GCC can sell whatever is produced.
4. Currently, Grace pays her only employee a fixed salary of $120 for the weekend. She is considering changing this to a per chocolate piece rate of $0.05/chocolate. Assuming that GCC faces future uncertainty about volume, what would be one advantage and one disadvantage of paying a piece rate, in terms of GCC's future profitability (assume that operationally, this would have no effect). Look at this strictly from the firm's perspective. Answer qualitatively and briefly (3-4 sentences).
Ice-cream maker business
What is your advice to Grace? Which compensation scheme should they implement? While reaching the overall conclusion, answer these specific questions.
5. Comparing Plan A to the current compensation arrangement:
a. Will Plan A achieve management's objective of an increased presence in the marketplace? Briefly explain.
b. From a sales- mix perspective, will the salespeople be promoting the product that one would logically expect? Briefly discuss.
c. Will the sales force likely be satisfied with the results of Plan A? Why?
d. Will Grace likely be satisfied with the resulting impact of Plan A on company profitability? Why?
6. Assume that Plan B is under consideration.
a. Compare Plan A and Plan B with respect to total units sold and the sales mix. Comment on the results.
b. In comparison with flat salaries, is Plan B more attractive to the sales force? To the company? Show calculations to support your answers.