Question

Stratford Company makes a product that sells for $15 per unit' Variable costs are $6 per unit, and fixed costs total $180,000 annually.

Assume again that the company sold 28,000 units last year. The president feels that it would be unwise to change the selling price' instead, he wants to increase the sales commission by $2 per unit. He thinks that this move, combined with some increase in advertising, would cause annual sales to double. By how much could advertising be increased with profits remaining unchanged?

Answer 1

Current profit = Selling price - variable cost

= 15-6 = 9 per unit

Total profit = 28,000*9 = 252,000 - 180,000

= $72,000

So sales commission is increased by 2 therefore the variable cost will increase by 2.

However units sold will be 56,000 and profit will remain the same as of 72,000 as well as the selling price per unit which is 15.

Let the advertisement expenses be X

Net profit = (Selling price- variable cost)*56,000 - advertising expense - fixed cost

72,000 = (15 -8)*56,000 - X - 180,000

72,000 = 392,000 - X - 180,000

X = 392,000 - 180,000 - 72,000

= $140,000.

Therefore total advertisement expense will be $140,000 in order to maintain the same profit.

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