Question

The group product manager for ointments at American Therapeutic Corpora-tion was reviewing price and promotion alternatives for two products: Rash-Away and Red-Away Both products were designed to reduce skin irritation, but Red-Away was primarily a cosmetic treatment whereas Rash-Away also included a compound that eliminated the rash.

The price and promotion alternatives recommended for the two prod¬ucts by their respective brand managers included the possibility of using ad¬ditional promotion or a price reduction to stimulate sales volume. A volume, price, and cost summary for the two products follows:

Rash-Away RedAway
Unit price $2.00 $1.00
Unit variable costs 1.40 0.25
Unit contribution $0.60 $0.75
Unit volume 1,000,000 units 1,500,000 units

Both brand managers included a recommendation to either reduce price by 10 percent or invest an incremental $150,000 in advertising.

How many additional sales dollars must be produced to cover each $1.00 of incremental advertising for Rash-Away? For Red-Away?

Answer 1

According to the given information,

Unit price for Rash-Away = $2.00

Unit price for Red-Away = $1.00

Unit variable cost for Rash-Away = $1.40

Unit variable cost for Red-Away = $0.25

Unit contribution for Rash-Away = $0.60

Unit contribution for Red-Away = $0.75

Unit Volume for Rash-Away = 1,000,000 units

Unit volume for Red-Away = 1,500,000 units

If both managers reduce price by 10% or invest an additional $150,000 in Advertising, then the unit price will be calculated as:

Let us assume that they invest additional $150,000 in Advertising.

a) Additional sales that must be produced to cover the incremental advertising expense is calculated as:

For Rash-Away:

For $1 of Advertising expense, the  variable costs contributes 70% while the Contribution margin is 30%.

                                       Additional sales = $1 / 30%

                                                                = $1 / 0.3

                                                                = $3.33

Therefore, the additional sales dollars to cover the incremental advertising expense is

Additional sales dollars = $3.33 * 1,000,000

                                   = $3,330,000

For Red-Away:

For $1 of Advertising expense, the  variable costs contributes 25% while the Contribution margin is 75%.

                                       Additional sales = $1 / 75%

                                                                = $1 / 0.75

                                                                = $1.33

Therefore, the additional sales dollars to cover the incremental advertising expense is

Additional sales dollars = $1.33 * 1,500,000

                                   = $1,995,000