Healthy Spring Water Company
HEALTHY SPRING WATER COMPANY
PROBLEM 1a
DEFINING THE PRICE-VOLUME TRADEOFF
FOR A 20% PRICE INCREASE
The Health Spring Water Company sells bottled water for offices and homes. The price of the water is $20 per 10 gallon bottle and the company currently sells 2,000 bottles per day. Following is a summary of the company’s income and costs on a daily basis.
Sales Revenue $40,000 Incremental Variable Costs $16,000 Nonincremental Fixed Costs $20,000
Note: You can assume that variable costs are constant so that the average of them is the variable cost relevant for a change in sales.
One can calculate the change in sales volume necessary for the price change to be profitable by using the following Basic Breakeven Sales Change formula:
% BE Sales Change = - Change in Price (Basic Calculation) CM + Change in Price
The company is enjoying stable demand with its current pricing, but management is looking for ways to increase profitability. One suggestion is that the company reposition its water as a premium product, justifying a higher price. If successful, the company believes that it could charge 20% more for its water than it does now.
1. What is the maximum sales loss (in % and units) that Healthy Spring could tolerate before a 20% price increase would fail to make a contribution to profit? (That is, what is the basic breakeven sales change?)
2. By how much would Healthy Spring’s contribution increase if its sales declined by 15% following the price increase?
HEALTHY SPRING WATER COMPANY
PROBLEM 1b
BREAKEVEN CALCULATIONS WITH
A CHANGE IN VARIABLE COSTS
It is usually not possible to raise a price substantially without also improving the product and/or its promotion. Consequently, a price change often involves a corresponding change in the incremental variable cost.
% BE Sales Change = - Change in CM (with a Change in VC) CM + Change in CM
= - (Change in Price - Change in VC)
PROBLEM 1a
DEFINING THE PRICE-VOLUME TRADEOFF
FOR A 20% PRICE INCREASE
The Health Spring Water Company sells bottled water for offices and homes. The price of the water is $20 per 10 gallon bottle and the company currently sells 2,000 bottles per day. Following is a summary of the company’s income and costs on a daily basis.
Sales Revenue $40,000 Incremental Variable Costs $16,000 Nonincremental Fixed Costs $20,000
Note: You can assume that variable costs are constant so that the average of them is the variable cost relevant for a change in sales.
One can calculate the change in sales volume necessary for the price change to be profitable by using the following Basic Breakeven Sales Change formula:
% BE Sales Change = - Change in Price (Basic Calculation) CM + Change in Price
The company is enjoying stable demand with its current pricing, but management is looking for ways to increase profitability. One suggestion is that the company reposition its water as a premium product, justifying a higher price. If successful, the company believes that it could charge 20% more for its water than it does now.
1. What is the maximum sales loss (in % and units) that Healthy Spring could tolerate before a 20% price increase would fail to make a contribution to profit? (That is, what is the basic breakeven sales change?)
2. By how much would Healthy Spring’s contribution increase if its sales declined by 15% following the price increase?
HEALTHY SPRING WATER COMPANY
PROBLEM 1b
BREAKEVEN CALCULATIONS WITH
A CHANGE IN VARIABLE COSTS
It is usually not possible to raise a price substantially without also improving the product and/or its promotion. Consequently, a price change often involves a corresponding change in the incremental variable cost.
% BE Sales Change = - Change in CM (with a Change in VC) CM + Change in CM
= - (Change in Price - Change in VC)