Question 1. (special order)

You sell high-quality fake IDs to college students at a regular price of $80. Your financial results for 2009 are summarized in the following contribution margin statement:
2009
Sales volume (#units) 120
Revenue $9,600
Variable costs $1,800
Contribution margin $7,800
Fixed costs $1,300
Profit $6,500
Special order: You have been approached by a client who wants to buy 30 units at a discounted price of $20 per unit. You have enough spare capacity to fulfill this special order without cutting back on your regular business (120 units at $80).

Required:

A) Use the gross approach to decide whether you should fulfill this special order:
1. Compute total profit with the special order (total for the regular business plus the special order). To do that, compute total revenue, costs, etc with special order:
Total revenue=$
Total VC=$
Total CM=$
Total FC=$
Profit = $
2. Make a decision based on total profits with and without the special order. Should you take this special order?
(enter 1 if yes, 2 if no)

B) Use the incremental approach to decide whether you should fulfill this special order:
1. Compute the incremental profit, I.e. the change in profits relative to the status quo (status quo = no special order). To do that, compute incremental revenue (change in revenue), incremental variable costs, etc:
Incremental revenue=$
Incremental VC=$
Incremental CM=$
Incremental FC=$
Incremental profit = $
2. Make a decision based on incremental profits. Should you take this special order?
(enter 1 if yes, 2 if no)

C) If you reached different conclusions in (a) and (b), explain why they are different. If you reached the same conclusions in (a) and (b), also explain why, and whether it is a coincidence or a general pattern.

Question 2. (price cuts vs promotions)

Your regular price is $20/unit, unit variable cost is $10/unit and fixed costs are $3,000 per month. Because of the recession, your sales have dropped to 200 units a month, so you are losing money. You are considering two options to increase sales:
(1) reduce the price to $18/unit, or
(2) run an advertising campaign, which will cost you $300 a month, but keep the price at $20/unit.
In both scenarios, you estimate that sales will increase by 20%, from 200 to 240 units per month.

Required:

A) Compute total revenues, costs and profits under the status quo (original situation), and for each of the two new options.
status quo price reduction advertising
Revenue $ $ $
Variable costs $ $ $
Contribution margin $ $ $
Fixed costs $ $ $
Profit* $ $ $
* enter negative numbers with a minus sign, I.e. Enter negative 500 as -500, not as (500) or ($500).

B) Based on your results in (a), what should you do: do nothing, reduce the price or run the advertising campaign?
(enter 1 for "do nothing", 2 for "reduce price", 3 for "advertising")

C) If you solved (a) and (b) correctly, you are still losing money despite choosing the best option. Should you shut down your business in the short term? Explain why or why not.

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