Break-even Analysis Somerset Inc. has finished a new video game, Snowboard Challenge. Management...

Question:

Break-even Analysis Somerset Inc. has finished a new video game, Snowboard Challenge. Management is now considering its marketing strategies.

The following information is available:

Anticipated Sales Per Unit - $80

Variable Cost Per Unit - $35

Anticipated Volume - $1,000,000

Units Production Costs - $20,000,000

Anticipated Advertising - $15,000,000

Variable cost per unit includes the cost of the video game, packaging, and copying costs.

Two managers, James Hamilton and Thomas Seymour, had the following discussion of ways to increase the profitability of this new offering:

James: I think we need to think of some way to increase our profitability. Do you have any ideas?

Thomas: Well, I think the best strategy would be to become aggressive on price.

James: How aggressive?

Thomas: If we drop the price to $60 per unit and maintain our advertising budget at $15,000,000, I think we will generate total sales of 2,000,000 units.

James: I think that's the wrong way to go. You're giving too much up on price. Instead, I think we need to follow an aggressive advertising strategy.

Thomas: How aggressive?

James: If we increase our advertising to a total of $25,000,000, we should be able to increase sales volume to 1,400,000 units without any change in price.

Thomas: I don't think that's reasonable. We'll never cover the increased advertising costs.

Which strategy is best:

Do nothing?

Follow the advice of Thomas Seymour?

Or follow James Hamilton's strategy?

Cost Behavior:

The principles of cost behavior are applied to calculate the operating income for various activity levels. These principles state that fixed costs remain the same in total when volume changes, but total variable costs changes when the activity level change.

Answer and Explanation: 1

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Let us calculate the operating income for the three alternatives to find the answer. Note how the variable cost per unit and the total fixed...

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Cost-Volume-Profit Analysis: Definition & Examples

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Chapter 3 / Lesson 3
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Cost-volume profit analysis identifies the ideal production and pricing standards to reach company goals by comparing the cost to sales volume. Learn the formula for this analysis and the inclusion of contribution margin ratios in decision-making.


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