Question

Karges Coffee Inc. manufactures a line of single-cup brewing machines for home and office use that brew a cup of coffee, tea, or hot chocolate in less than a minute. The machines use specially packaged portions of coffee, tea, or hot chocolate that can be purchased online directly from Karges or at specialty coffee shops licensed to distribute the company's products. The appeal of the brewing machines is twofold. First, they offer a high level of convenience. The use of prepackaged coffee servings means no grinding of coffee beans and no mess. Also, the brewing machines have a water reservoir that for some models is large enough to make up to 20 cups of coffee. Second, the taste of each cup of coffee, tea, or hot chocolate is very consistent. The brewers’ pressurized system uses the same amount of water for each cup, and the airtight seal used in the individual portions keeps the product fresh.

The company has three models of brewers that offer different features, such as the size of the water reservoir, the number of brewing sizes, and the types of filtering devices used in the machine. Data from the most recent fiscal year for the three models are shown below:

	Model
	Home Brewer	Office Basic	Office Deluxe
Sales Volume (units)	12,000	30,000	6,000
Unit selling price	$150	$200	$300
Variable cost per unit	$120	$140	$180
Contribution margin per unit	$30	$60	$120

Fixed costs are $1,500,000 per year. The company has no work in process or finished goods inventories. The company is facing increased levels of competition from manufacturers using similar brewing technologies and believes there is no room for any increases in unit selling prices.

Required:

1. The company is considering a new advertising campaign to raise overall consumer awareness of the product offerings. The total cost of the year-long campaign would be $180,000.

a) By how much would unit sales need to increase overall for the company to be able to justify the new campaign?

b) How many units of each product must be sold to justify the new campaign? Assume no change to the current product mix.

2. Suppose that instead of being designed to increase total volume, the new $180,000 advertising campaign will focus on getting customers who would have purchased the Office Basic model to buy the Office Deluxe model instead.

a) To justify the cost of the new advertising, how many customers must purchase the Deluxe model instead of the Basic model?  Assume that the new advertising campaign will have no impact on sales of Home Brewer model

Answer 1

1. Cost of new Ad campaign = 180,000

No. of incremental sales mix units = 180,000/ 480 = 375

In order to justify the campaign, the company should be able to use incremental units to recover the cost incurred for the campaign via contribution

Home brewer = 375 x 2 = 750

Office basic = 375 x 5 = 1,875

Office deluxe = 375 x 1 = 375

2. Cost of new ad campaign = 180,000

Contribution of office deluxe = 120

Contribution of office basic = 60

Difference in contribution = 120 - 60 = 60

No. of units increase in office deluxe to justify campaign = Cost incurred/ difference in contribution

= 180,000/ 60 = 3000 units