Question

2-50 What-if analysis Tenneco Inc. produces three models of tennis rackets: standard, deluxe, and pro. Following are the sales and cost information for last year: $17 ITEM STANDARD DELUXE PRO Sales (in units) .. 100,000 50,000 50,000 Sales price per unit $30 $40 $50 Variable manufacturing cost per unit .... $20 $25 Fixed manufacturing costs are $800,000, and fixed selling and administrative costs are $400,000. In addition, the company pays its sales representatives a commission equal to 10% of the price of each racket sold. Required (a) If the sales price of deluxe rackets decreases 10%, its sales are expected to increase 30%, but sales of standard rackets are expected to decrease 5%, as some potential buyers of standard rackets will upgrade to deluxe rackets. What will be the impact of this decision on Tenneco's profits? (b) Suppose that Tenneco decides to increase its advertising by $50,000 instead of cutting the price of deluxe rackets. This is expected to increase sales of all three models by 2% each. Is this decision advisable? (c) The incentive created by sales commissions has led Tenneco's sales force to push the higher priced rackets more than the lower-priced ones. Is this in the best interests of the company?

Answer 1

Existing Profit Statement

Particulars Standard Deluxe Pro Total

Sales Units 100000 50000 50000

Selling Price p.u. $30 $40 $50

(-)Variable Manu. Cost p.u. ($17) ($20) ($25)

(-) Sales Commission ($3) ($4) ($5)

Contribution p.u. $10 $16 $20

Total Contribution $1000000 $800000 $1000000 $2800000

(-)Fixed Manu Cost ($800000)

(-)Fixed Selling & Admin Cost     ($400000)

Total Profit $1600000

(a) Revised Sales Units 95000 (100000-5%) 65000(50000+30%) 50000 210000

Revised Contribution p.u. $10   $12.4($36-$20-$3.6) $20

Total Contribution $950000 $806000 $1000000 $2756000

(-)Fixed Manu Cost   ($800000)

(-)Fixed Selling & Admin Cost ($400000)

Total Profit $1556000

Total Profit is reduced by $44000 ($1600000-$1556000)

(b) Revised Sales units 102000 51000 51000

Contribution p.u. $10 $16 $20

Total Contribution $1020000 $816000 $1020000 $2856000

(-)Fixed Manu Cost ($800000)

(-)Fixed Selling & Admin Cost [$400000+$50000] ($450000)

Total Profit $1606000

Total profit increased by $6000($1606000-$1600000)

(c)Yes ,This is in the best interest of the company. As the Higher Priced Product Pro Contribution per unit is also higher i.e. $20. So if the sales force push the production of Higher Price Product the overall contribution will increase.