Estimating cost functions and CVP relationships A boat manufacturing firm, BanuCraft, started operations two years ago. The company manufactures only one type of boat, a 22 foot cuddy cabin. The boat is popular for water skiing, other water sports and fishing. The company has established a good quality reputation. While the boat seems to be selling quite well because of its competitive price and high quality, the owners would like to be able to understand better the financial dimensions of their business. The owners say that there have been no increases in costs or prices for the two years. Sales volume has been going up but profits seem to increase at a faster rate than suggested by the sales increase. They would like to understand the reason behind this phenomenon. Also, after the recent boat and fishing show, some of the company's salespeople approached the owners with several suggestions. The salespeople said that customers reacted favorably to the company's policy of holding the line on prices for 1993. But they suggested that the company can sell more BanuCrafts at a higher price with more advertising to acquaint people with the boat's unique features and high quality. The company retains the services of an advertising agency which is paid a flat sum every year. According to the owners, the suggested advertising campaign would increase the fixed selling costs by $55,000. Some prospective buyers suggested that the company should outfit the boats for fishing. Suggestions include the installation of fish and depth finders, marine radios and Loran-Cs. Also suggested were trolling plates, rod holders, speed and temperature gauges and electric downriggers for trolling. These items would cost $1,500 per boat wholesale but other manufac- turing costs would not be affected. The suggested improvements and increased advertising together would enable the company to increase 1994 sales of BanuCraft by 70 percent over 1993 levels instead of the usual growth rate which is not expected to change without the improvements. Also, these improvements would enable BanuCraft to increase the 1994 price by $3,000 over the 1993 price. Sales commissions vary proportionately with sales revenues. The company sold every boat that it manufactured in both years. The following are the income statements for Banu- Craft which uses an actual costing system:

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Sales (120 units).. Cost of goods sold Gross profit.... BanuCraft Income Statements For the Years Ended 1992 and 1993 Selling expenses (commissions and advertising) General administration... Profit before tax Income tax Profit after tax 1992 $2,400,000 1993 $3,600,000 1,600,000 $ 800,000 2,260,000 $1,340,000 400,000 580,000 240,000 $ 160,000 64.000 300,000 $ 460,000 184,000 $ 96,000 $ 276,000 REQUIRED a. Compute break-even in sales dollars and units for 1992. Explain why profits have increased at a faster rate than sales revenue. b. Before considering the suggested improvements, what sales level does BanuCraft have to reach in order to earn after-tax profits of $420,000 in 1994? Assume that all other relationships will stay the same. c. Discuss whether the new advertising campaign and suggested outfitting should be under- taken solely on financial grounds. In your presentation include break even for 1994, and estimated profits as well as other relevant data. Provide schedules to support your position. d. What other quantitative and qualitative issues need to be considered before a decision is made to expand sales and manufacturing facilities?