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Sales Strategy: Selecting the Better Strategy

Gobi Inc. has sales of $40,000,000. The contribution margin is 40% and the fixed costs are $3,000,000. The variable cost per unit is $12. The company is considering two different strategies for increasing their profits:

1) Spend $2,000,000 in advertising: the results is expected to increase the company's sales by 25%
2) Reduce the price by 20%; the price-demand elasticity is -3.0

Which of the two strategies will generate the highest overall profits?

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Solution Preview

Current Sales=40,000,000
Contribution margin ratio=CMR=40%
Contribution margin ($)=CM=Sales*CMR=40000000*40%=$16,000,000
Fixed Costs= 3,000,000
Operating profit=CM- fixed Cost=16,000,000-3,000,000=$13,000,000

1. Spend $2,000,000 in advertising; results expected to increase sales by 25%

Expected Sales=40000000*(1+25%)=$50,000,000
Contribution margin ratio=CMR=40%
Contribution margin ...

Solution Summary

This solution determines which strategy gives higher profits. Formula and calculations are provided and answers are explained.