AJ Ventures Ltd is a company engaged in the manufacture of water bottles
which are bought mainly for sporting activities. Present sales are direct to
retailers, but in recent years there has been a steady decline in output
because of increasing foreign competition. In the last business year (2020)
the company produced its lowest profit in ten (10) years. The forecast for
2021 indicates that the present deterioration in profits is likely to continue.
The company considers that a profit of $80,000 should be achieved to
provide an adequate return on capital. The managing director has asked
that a review be made of the present pricing and marketing policies. The
marketing director has completed this review, and passes the proposals on
to you for evaluation and recommendation, together with the Income
statement for the year ending December 31, 2020 (see below).
AJ Ventures limited.
INCOME STATEMENT
For the Year Ending, December 31, 2020
Sales Revenue (100,000 Bottles at $10) $1,000,000
Cost of goods sold
Direct Materials $100,000
Direct Labour 350,000
Variable Manufacturing overheads 60,000
Fixed Manufacturing overheads 220,000
$730,000
Administrative Overhead 140,000
Selling and Distribution Overhead
Sales commission (2% of sales) 20,000
Delivery cost (variable per unit sold) 50,000
Fixed costs 40,000
110,000
$980,000
Income $20,000
The information to be submitted to the managing director includes the
following three proposals:
(i) To proceed on the basis of analyses of market research studies that
indicate that the demand for the bottles is such that a 10% reduction in
selling price would increase demand by 40 %.
(ii) To proceed with an enquiry that the marketing director has had from a
mail order company about the possibility of purchasing 50,000 bottles
annually if the selling price is right. The mail order company would
transport the bottles from AJ ventures to its own warehouse, and no sales
commission would be paid on these sales by AJ ventures. However, if an
acceptable price can be negotiated, AJ ventures would be expected to
contribute $60,000 per annum towards the cost of producing the mail order
catalogue. It would also be necessary for AJ ventures to provide special
additional packaging at a cost of $0.50 per bottle. The marketing director
considers that in 2019 the sales from existing business would remain
unchanged at 100,000 bottles, based on a selling price of $10 if the mail
order contract is undertaken.
(iii) To proceed on the basis of a view held by the marketing director that a
10% price reduction, together with a national advertising campaign costing
$30,000, may increase sales to the maximum capacity of 160,000 bottles.
Required
d. A calculation of the minimum prices that would have to be quoted to the
mail order company to
I. ensure that AJ ventures would at least break even on the mail order
contract
II. ensure that the same overall profit is earned as in proposal (i) from the
mail order contract.
III. Ensure that the overall target profit is earned, from the mail order
contract.
e. A financial evaluation of proposal (iii)