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# Finance assignment question 6

Q1. (2 points)

The volume of books that One.com, an online book retailer, needed to sell in order to break-even in July 2014 was 10,000 units. Fixed expenses per month (salaries and warehousing) are \$60,000. The selling price per book is \$10. In August 2014, One.com decides to acquire author-signed copies of all books. Because of this, variable costs in August are expected to increase by 25% over the previous month.

What is the breakeven volume for August 2014, assuming the price per book does not change? Please present your workings clearly.

Let the variable cost of each book be VC.

Breakeven volume = Fixed cost / (price-VC)

For July, 10,000=60,000/(10-VC)

OR VC=\$4 per book in July.

VC in August = 125% of \$4 = \$5

Since prices remain unchanged, breakeven volume for August = Fixed cost per month/ (price – new VC) = 60,000/(\$10-\$5)=12,000 units per month. 2 points if BE volume is 12000. 1 point if BE volume is incorrect, but VC for August is correctly computed. 0 points otherwise.

QUESTIONS 2 and 3 are based on the following business situation:

Peter Rossi is considering starting a company called DollCo, which would be in the business of making and selling cute porcelain dolls. To investigate demand, Peter makes some sample figurines and hires Marketalpha, a NY-based firm, to conduct some marketing research. Marketalpha suggests that DollCo should sell its products in three states only: NY, NJ and CT. It determines that DollCo’s market share (by volume) in the first year of operation will be 0.3% in NY, 0.5% in NJ and 0.1% in

1. Peter thinks that he should go into business, and decides to follow Marketalpha’s recommendations. He has turned to you to help him work out a business plan. DollCo plans to manufacture the dolls in a rented manufacturing facility (monthly rent is \$2,000) and to lease an assembly machine for \$66,000 per year. Additionally, it will cost DollCo \$3 per doll in materials and labor. Peter plans to sell the dolls through Amazon.com. Amazon will buy the dolls from DollCo for \$18 per doll and sell them to final consumers to make a 15% margin per doll. Per the arrangement with Amazon, DollCo will be responsible for delivering the doll to the final consumer. DollCo will incur a cost of \$6 per doll, to be paid to a shipping company for this service. Other than those mentioned above, there are no costs (depreciation, taxes, etc.) or revenues associated with the business. For the sake of simplicity, ignore all costs that DollCo would have to incur after the first year, and all revenues that the business would generate after the first year. Marketalpha estimates the total market size of dolls to be 2 million units per year in NY, 1 million units per year in NJ, and 3 million units per year in CT.
2. Q2. (1 point) What is the estimated sales volume (in units of dolls) for DollCo in the first year based on the market research? Please present your workings clearly.

Volume sales in NY = 0.3% X 2 million = 6,000 units

Volume sales in NJ = 0.5% X 1 million = 5,000 units

Volume sales in CT = 0.1% X 3 million = 3,000 units

Total volume sales = 6,000+5,000+3,000 = 14,000 units.

1 point for correct response of 14,000 units.

0.5 point if total sales volume is incorrect, but it was mentioned that market size should be multiplied

by market share.

0 points otherwise.

Q3. (2 points) What is the breakeven volume (in units of dolls) for DollCo for the first year? Please present your workings clearly.

Fixed cost per year = rent per year + machine leasing cost per year = (2000 X 12)+66000=\$90,000

Variable cost = \$3 (materials, labor, etc.) + \$6 (transportation) = \$9 per unit

Price at which DollCo sells = \$18 per unit

Breakeven volume = Fixed cost / (price-variable cost)=90,000/(\$18-\$9)=10,000 units.

2 points for correct response of 10,000 units.

IF BE VOLUME IS INCORRECT:

1 point if at least one of the following is correctly computed: fixed cost, variable cost 0 points otherwise.

Q4. (2 points) Organic foods is one of the fastest growing industries in the US. Consider a 32-oz cup of organic yogurt which consumers buy from supermarkets at an average retail price of \$4.00. Dannon, a prominent player in the industry, manufactures organic yogurt in various cup sizes and ships all its products to organic foods distributors. Distributors then deliver the products to individual supermarkets. For a 32-oz cup of organic yogurt, the typical distributor margin is 9% and supermarket margin is 35%. If the variable cost of production of a 32-oz cup is \$2.00, what is the unit contribution (in \$ per cup) earned by Dannon? Please present your workings clearly. Hint: Margin is specified as a percentage of the selling price of the agent. Margin = (selling price – purchase price) / selling price

For supermarkets, margin = 35%, selling price = \$4.00.

So purchase price = 4.00 X (1-.35)=\$2.60

For distributors, margin = 9%, selling price = \$2.60.

So purchase price for distributor = selling price for Dannon = 2.60 X (1-.09)=\$2.37

For Dannon, contribution = Price – variable cost = \$2.37-\$2 = \$0.37 per cup.

2 points for correct response of \$0.37 per cup.

IF CONTRIBUTION IS INCORRECT

1 point if purchase price for distributor is correctly computed as \$2.37. 0 points otherwise.

Q5. (3 points) Two.com, a very successful online retailer of diapers and other baby products, estimates that each of its existing consumers makes 10 purchases per year. 60% of these purchases are for “Big Diapers” and the remaining are for “Small Diapers”. The contribution margin per purchase is \$2.00 for Big Diapers and \$0.20 for Small Diapers. Each year Two.com experiences a churn of 90% of its customer base (or 90% of its customers never buy its products again), presumably because its products are not relevant for babies over a certain age. What is the maximum (in \$ per customer) the firm should be willing to spend on acquiring a customer? Use the concept of customer lifetime value to answer this question. Assume a lifetime of three years, and negligible marketing communication costs. Also assume that cash flows do not need to be discounted in time.

Let the acquisition cost be AC.

Each consumer purchases 6 Big Diapers and 4 Small Diapers every year.

Margin, m is (\$2 per purchase of Big Diapers X 6 purchases/year) + (\$0.2 per purchase of Small

Diapers X 4 purchases/year) = \$12.8 per year

Retention rate, RR is 1-90% = 10%.

Applying the formula for CLV:

CLV=12.8+(12.8X0.1) +(12.8X0.1X0.1)-AC

Or CLV=\$14.208-AC

At maximum AC, CLV=0, i.e. maximum AC=\$14.208 or \$14.21 (approximately).

3 points for answer of \$14.208 or \$14.21 or \$14.2.

1.5 points if answer is incorrect, but margin per year is correctly computed as \$12.8.

0 points otherwise.