Question

ENTREPRENEURIAL DECISION C1 A1 BTN 5-5 Ellis Island Tropical Tea, launched by entrepreneur Nailah Ellis-Brown as described in this chapter's opener, makes Jamaican sweet tea from all-natural ingredients. Required 1. Identify at least two fixed costs that do not change regardless of how much tea Nailah's company sells. 2. Ellis Island Tropical Tea is growing. How could overly optimistic sales estimates hurt Nailah's business? 3. Explain how cost-volume-profit analysis can help Nailah manage her company.

Answer 1

1. Examples of fixed cost that do not change

· Rent

· Office salaries

· Depreciation

· Advertising

· Insurance

2. Overly optimistic sales estimate can hurt Nailah’s Contribution margin and Net operating income. The higher sales estimate will give higher contribution margin based on which additional fixed cost related expenditure would have been incurred. When higher sales do not materialise the fixed cost remain the same and lower contribution margin will lead to net operating losses in the business.

3. Cost –volume-profit analysis can help in below ways

· CVP analysis helps in understanding the cost structure of the company and its inter-relationship with volume

· It helps in calculation of breakeven point. Breakeven point is the point at which there is no profit or loss for the firm

· It helps in understanding margin of safety. Margin of safety is difference between actual sales and break even sales which yields profit to the firm

· It helps in analysing profitability at different levels of output

· It helps in evaluation of various alternatives. For example: Increase or decrease selling price, advertisement investment, new machine investment, etc

· It helps in various decisions making. for example : pricing decisions, product mix , continue or discontinue of division or product lines