- 16 Marks
MA – April 2022 – L2 – Q5a – Decision making techniques
Analyze the profitability of four strategic options for Kuntu Ltd and estimate the required selling price to achieve a target profit.
Question
Kuntu Ltd manufactures one standard product, the standard marginal cost of which is as follows:
| Cost Element | GH¢ |
|---|---|
| Direct material per unit | 10.00 |
| Direct wages per unit | 7.50 |
| Variable production overhead | 1.25 |
| Total Marginal Cost per Unit | 18.75 |
The budget for the year includes the following:
- Output (units): 80,000
- Total fixed Overheads:
- Production: GH¢1,000,000
- Advertising: GH¢600,000
- Marketing: GH¢500,000
- Contribution: GH¢2,500,000
In reviewing the budget for the coming year, management is dissatisfied with the results likely to arise. An emergency board meeting was held to discuss possible strategies to improve the situation, and the following strategies were proposed:
Strategy 1: The Production Manager suggested reducing the selling price by 10%. This could increase output by 25%. It is estimated that these changes would result in an increase in fixed production overhead by GH¢50,000 and fixed marketing overhead by GH¢25,000.
Strategy 2: The Director of Finance suggested increasing the selling price by 10%. Additionally, with an increase in advertising cost by GH¢400,000, sales units would increase to 90,000 units. It is also estimated that this strategy would increase the fixed production overhead by GH¢25,000 and marketing overhead by GH¢20,000.
Strategy 3: The Marketing Director suggested that with an appropriate increase in advertising expenditure, sales could be increased by 20%, and a profit on turnover of 15% could be obtained. It is estimated that fixed production overhead would increase to GH¢1,040,000 and marketing overhead would increase by GH¢25,000.
Strategy 4: The Managing Director seeks a profit of GH¢600,000. He would like to know at what selling price the target profit could be achieved given the following estimates: An increase in advertising expenditure by GH¢360,000 would result in a 10% increase in sales. However, fixed production and marketing overheads would increase by GH¢25,000 and GH¢17,000 respectively.
Required:
i) Prepare a forecast profit statement for Strategy 1 and Strategy 2. (6 marks)
ii) Estimate the additional expenditure on advertisement to achieve results in Strategy 3. (5 marks)
iii) Estimate the selling price that is required to achieve a profit of GH¢600,000 in Strategy 4. (5 marks)
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