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Selecting the better strategy

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Gobi Inc. has sales of $40,000,000. Contribution margin 40%, fixed costs $3,000,000, variable costs per unit $12. Company considering two different strategies for increasing profits:

1. Spend $2,000,000 in advertising; results expected to increase sales by 25%
2. Reduce price by 20%; price-demand elasticity is -3.0

Which of two strategies will generate highest overall profits?

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Solution Summary

Solution selects the strategy that gives better profits.

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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 provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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