Question

American Airlines has $100 variable cost on $500 coach class three-week advance-purchase seats from New York to Florida. The company is quite conscious of their need to sustain cumulative operating profits in order to cover their very high fixed costs of pilot crews, capital equipment leases, and hub airports. a)(8 points) The product team proposes to discount these NY-Fla routes with a 5% price cut to $475.Variable costs remain $100. What “break point” percentage increase in unit sales of American seats must occur in response to the 5% price cut in order to maintain cumulative operating profits? Show your work. b)(4 points) Does this unit sales increase goal seem possible? Why or why not? c)(8 points) American Airline’s branding team simultaneously receives a $7 million ad campaign proposal from American’s ad agency. The incremental sales over the projected 90-day lifetime of the demand effects attributable to the ad campaign total 20,000 additional seats sold. At the $475 price point and $100 variable costs, should the ad proposal be adopted or refused? Show your work. 3.

Answer 1

1.

Here the Total Fixed Cost is constant. So let's assume it as $1000

Break even point = Total Fixed cost/ ( Sales price per unit - Variable cost per unit)

Initial Sales price = $ 500

Initial Variable cost = $ 100

Break Even point = 1000/(500-100) = 2.5

Sales price after discount = $ 475

Variable cost after discount = $100

Break Even point = 1000/(475-100) = 2.67( rounded figure)

Percentage change in break even point =

(Final BEP - Initial BEP)/ Initial BEP =. [(2.67-2.5)/2.5 ]*100 = 6.8%

So there should be an increase of 6.8% of BEP inorder to maintain the cumulative profit.