CHOCOBAN LTD.

Chocoban is a well-established producer and marketer of the finest boxed chocolate and was started ten
years ago by two partners, Henry See and John Juan. Prior to their partnership, Henry was marketing
vice-president while John served as comptroller in a candy company with national distribution. The two
men agreed at the outset that Henry would handle distribution and marketing and John would look after
production, accounting and company finances; overall planning and major decisions would be agreed
upon by both.

The partners have decided to position the company product in the medium-high price range. They were
successful in developing and selling a quality chocolate and enjoyed an edge over competition. Their
single manufacturing plant served a densely populated market. With increasing customer acceptance,
20 retail outlets were opened. Until recently, growth seemed limited only by financial resources. In the
past months, however, each partner unearthed information that raised concern to both. Reviewing costs,
John discovered that production costs per kg of candy were rising with each new retail outlet opened.
He realized that the company has outgrown the production expertise of the present management staff.

Henry’s revelation was even more disturbing. He noted that sales have begun to drop off in several of
the stores. He found that in each instance, an aggressive competitor with a lower-priced line has moved
into their territory. Meeting John, he observed, “People can’t taste quality any more. I feel strongly that
we should develop a cheaper line as quickly as possible, to sell for around half our present price. We
should cut our production of the premium line to half its present rate and use the extra cocoa beans for
our new line.” John agreed to look into recipes, costs and schedule.

A week later, John met with Henry again, this time to report his findings. “Our kitchen has developed two
recipes that we can make at a lower price. We think each recipe will satisfy the public, but neither
comes near our premium line in quality. We have names to suggest for each formulation: Chocodant
and Chocomer. The only new equipment we will need is a mixer and a molder, and I have located both,
available on a lease arrangement with immediate delivery. I have put some costs together, that include
the leasing arrangement, new boxes, and all other expected production expenses. I have put this
information, schedule, etc., on this memo, which you can look over, then we can decide. However, I
think it fair to tell you that I have done some pencil pushing, and I don’t think this lower-priced line makes
for good business. You will see that every kg of the premium line now yields P43 in contribution, while
Chocodant will yield only P31.50 and Chocomer P27. We are strapped financially, and our cocoa bean
suppliers will not increase their shipments to us by more than 20% because of greater demand and level
supply. Finally, I question whether we should go to an inferior candy that might destroy our quality
image. Are you sure we can sell candy to our customers at these prices?”

Henry looked over the memo and then replied, “I would like to study this information for the next few
days. The prices that you have here aren’t geared to marketing and will have to be adjusted up or down
by a few centavos, but I will accept them as they are for my thinking. In reply to your last question, let
me say that we not only can sell all the candy we make at these prices, but we are in trouble if these new
lines don’t make financial sense.” The partners agree to meet again in a few days to make a decision.
Memo to: Mr. See
From: Mr. Juan
Re: New Product Considerations

A. New Equipment

There is no restriction on how the mixer and molder can be used, except that only one or the other
product can be on the mixer at one time, and the same applies to the molder. Thus, Chocodant can be
on mixing while Chocomer is molding. The reverse is also true. Both products require these two
manufacturing stages and they must share time on the equipment. The mixing machine can process
500 kg of Chocodant daily or 300 kg of Chocomer. The molding machine can process 271 kg of
Chocodant daily or 633 kg of Chocomer.

B. Cost and Pricing

Production costs (exclusive of cost of cocoa beans):

Premium line = P25 per kg.
Chocodant = P6 per kg.
Chocomer = P5.50 per kg.

The cost of cocoa beans as presently carried on the books is P9.50 per kg. In the past, the cost has
ranged from P7.50 to P11.50 per kg.

Cocoa bean requirements:

Premium line = 1 kg of candy, 6 kg beans (present allocation = 2400 kg of beans)
Chocodant = 1 kg of candy, 4 kg beans
Chocomer = 1 kg of candy, 3 kg beans

Projected selling price:

Premium line = P125 per kg (present price)
Chocodant = P75.50 per kg
Chocomer = P61 per kg