HEALTHY SPRING WATER COMPANY
The Healthy Spring Water company sells bottled water for offices and homes. The price of the water is $20 per 10 gallon bottle and the company currently sells 2000 bottles per day. Following is the company's income and costs on a daily basis.
Sales Revenue $40,000
Incremental Variable Cost $16,000
Nonincremental Fixed Cost $20,000
[Note: you can assume that variable costs are constant so that the average of them is also the variable cost relevant for a change in sales.]
The company is enjoying stable demand with its current pricing, but management is looking for ways to increase profitability. One suggestion is that the company repositions its water as a premium product, justifying a higher price. If successful, the company believes that it could charge 20% more for its water than it does now.
(a) What is the maximum sales loss (in % and units) that Healthy Spring could tolerate before a 20% price increase would fail to make a positive contribution to its profitability?
(b) By how much would Healthy Spring's contribution increase if its sales declined by 15% following the price increase?
In order for Healthy Spring to reposition itself as premium water, management believes that it will have to upgrade the packaging of its product. The company will deliver the water in glass rather than plastic bottles and the bottles will be "safety sealed" to insure their cleanliness until the covering is removed in the customer's home. These changes will add $1.00 per bottle to the variable cost of sales. Also, to reposition its water as a premium product, Healthy Spring will require an increase in its advertising and promotion budget of $900 daily.
(c) What is the maximum sales loss that Healthy Spring could tolerate before a 20% price increase would fail to increase its net profit?
The problem deals with how to make decisions by evaluating business functions through cost-volume-profit approach.