Business Proposals

Analysis
(a) This question requires a brief explanation of the theory of contribution
margin. When all variable expenses are deducted from sales what remains is
the contribution margin. It can be denoted as an absolute amount a unit
absolute amount or a percentage. A contribution margin ratio of twenty five
percent would mean that the variable expenses total seventy five out of a
total of sales figure of one hundred. !y definition the variable expenses will
vary with the quantity of production (at least in the short run and over a
certain production range) so there is little if any room for cost control vis"a"
vis the variable costs. The focus will therefore be on the excess of sales over
variable expenses. #bviously therefore the contribution margin will be higher
either
$ when the selling price of the coconut doughnut is higher than that of the
strawberry variety
$ and%or if the input raw materials of the coconut doughnut are cheaper
compared to those of strawberry doughnut with selling
price of both varieties remaining the same.
If the above guideline is followed it should be possible to determine the
product which warrants a cut bac& in production. !ul& order should not be
accepted in a situation where the expected contribution margin is equal to or
less than the current contribution margin wherein there is no bul& order. !ul&
order will require bigger plant higher investment in men and machines and
is not 'ustified if the contribution margin remains the same or goes down.
!esides the financial considerations there are other factors as well. Thus from
the mar&eting standpoint it would be preferable to retain both in order not to
narrow the wider customer base.
(b) In this part of the question it is implied that the present available
production capacity is inadequate to meet the demand. It would appear that
it has become necessary to have higher output through acquisition of new
plant or conversion of the present one to coconut doughnuts only. It has
been stated that the expected demand would exceed the current capacity by
())))) pieces.
The brea&even volume is higher than the bul& order by *)))) pieces. It
should not be too difficult to sell this extra quantity of *)))) pieces to retail
customers. #bviously the bul& order promises enough return and the surplus
quantity can even be sold off at suitably ad'usted prices if necessary.