Analysis
(a) This question requires a brief explanation
of the theory of contribution margin. When all
variable expenses are deducted from sales what
remains is the contribution margin. It can be
denoted as an absolute amount, a unit absolute
amount or a percentage. A contribution margin
ratio of twenty five percent would mean that the
variable expenses total seventy five out of a
total of sales figure of one hundred. By definition
the variable expenses will vary with the quantity
of production (at least in the short run and over
a certain production range) so there is little,
if any, room for cost control vis-a-vis the variable
costs. The focus will therefore be on the excess
of sales over variable expenses. Obviously therefore
the contribution margin will be higher either
* when the selling price of the coconut doughnut
is higher than that of the strawberry variety
* and/or if the input raw materials of the coconut
doughnut are cheaper compared to those of strawberry
doughnut, with selling
price of both varieties remaining the same.
If the above guideline is followed it should be
possible to determine the product which warrants
a cut back in production. Bulk order should not
be accepted in a situation where the expected
contribution margin is equal to or less than the
current contribution margin wherein there is no
bulk order. Bulk order will require bigger plant,
higher investment in men and machines and is not
justified if the contribution margin remains the
same or goes down. Besides the financial considerations
there are other factors as well. Thus from the
marketing standpoint it would be preferable to
retain both in order not to narrow the wider customer
base.
(b) In this part of the question it is implied
that the present available production capacity
is inadequate to meet the demand. It would appear
that it has become necessary to have higher output
through acquisition of new plant or conversion
of the present one to coconut doughnuts only.
It has been stated that the expected demand would
exceed the current capacity by 600,000 pieces.
The breakeven volume is higher than the bulk order
by 50,000 pieces. It should not be too difficult
to sell this extra quantity of 50,000 pieces to
retail customers. Obviously the bulk order promises
enough return and the surplus quantity can even
be sold off at suitably adjusted prices, if necessary.
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