Question

The ABC Company sells two products, S and Y. The following information is available:

S Y

Selling price $6.00 $4.00

Variable cost\unit. 3.50 2.00

Anticipated sales (units) 30,000 70,000

Fixed costs amount to $80,000

Management believes that it can increase sales by $50,000 of either product through a new advertising program. Capacity exists to increase production of either product. Should the advertising campaign be targeted to Product S or Product Y? Explain why? Provide financial support for your explanation

Answer 1

Let’s see the impact of additional sales $50000 on the profitability of each product;

	S	Y
Selling price per unit	$6	$4
Less: Variable cost per unit	($3.50)	($2)
Contribution margin	$2.5	$2
Contribution margin ratio (C / S)	41.67%	50%

So on the basis of contribution margin percentage, it is clear that product Y have higher contribution margin rate hence advertising campaign should be targeted to Product Y because it will result into higher net income.

Apart from this we can check it with the help of below calculations;

	S	Y
Selling price per unit	$6	$4
Number of anticipated units sold	30000	70000
Total sales	$180000	$280000
Additional sales	$50000	$50000
Total sales	$230000	$330000
Contribution margin ratio	41.67%	50%
Total contribution margin (Total sales * CM ratio)	$95841	$165000

Thus it is clear that total contribution margin after including possible sales is higher in case of product Y. Thus advertising campaign should be targeted to Product Y because it will result into higher net income.