CHILD'S PLAY COMPANY (A)Child's Play Company makes a plastic rattle for toddlers. The rattle is generally marketed through exclusive retailers located in upscale shopping malls. The company used 23 retailers. In late 2016, Diana Suares, the president of the company, was considering alternative marketing plans presented to her by Bill Dings, the marketing manager. Based on sales from January through October 2016, Diana expected that 2016sales would amount to 300,000 units at $8.00 per unit. Diana Suares also had with her some cost data for 2016supplied by the CFO, Don Capp. Don expects that these costs are reliable estimates for a volume up to 400,000 units. Beyond 400,000 units, the company would have to rent additional machines (with a capacity of 100,000 units each) at an annual cost of $50,000 per machine (in 2016).

The data are presented in Exhibit A.

Total fixed manufacturing and selling and administrative costs are each expected to increase in 2017by 10 percent because of inflation. Variable costs per unit and the selling price would stay the same as in 2016.

Exhibit A (2016Cost Data)Manufacturing costs for rattles (based on production volume of 300,000 units). Direct material $0.80 per unit * Direct labor $10 per hour * (Each worker can make 20 units in an hour) Packaging $0.75 per unit * Power, supplies, indirect labor, and other variable production costs $1.20 per unit * Supervisory salaries, equipment rental, and miscellaneous production costs $1.80 per unit

* These costs vary in total with production volume

Selling and administrative costs (based on sales volume of 300,000 units). Commissions to sales staff 10% of price to retailer ** Shipping $0.50 per unit ** Advertising and promotion $0.60 per unit Administrative staff salaries, depreciation on office equipment, etc $0.90 per unit

** These costs vary in total with sales volume.

CHILDS PLAY (B)Diana Suares is aware that unless the company changes its strategy in some way, its operations in 2017will be unprofitable. Alternative marketing plans for 2017are summarized below.

Plan A: Cut price At the present time we price the product to retailers at $8.00 per rattle. Retailers generally charge the consumers between $9.00 and $9.50. If we cut our price to retailers to $7.50, I expect that the product will do much better. Their increased markup will give them the incentive to display our product more prominently and to promote it more vigorously to customers. We should support this strategy by supplying more promotional materials to retailers, at least another $200 worth to each of our 23 retailers. I expect that we will be able to boost our sales volume by as much as 30 percent.

Plan B: Better packaging We have a well-designed, safe product which should be very appealing to affluent parents. However, our packaging appears cheap and unattractive. Some of our retailers feel that our product seems out of place in their store. If we improve our packaging, we should be able to boost sales. We have worked with our regular supplier to develop a new type of package that should boost sales by anywhere from 20 to 30 percent. They are willing to supply us the new packaging for $1.25 per unit.

Required:

1.Prepare an income statement for 2017, using the contribution format under Plan A. Ignore income taxes.

2.What isthe profit equation (as a function of volume) under Plan (A)? Plan (B)?

3.(a) There is one volume of sales at which both marketing plans give identical income (or loss). What is this volume? (b) Which plan would give higher income if the volume is (i)above and (ii) below the volume calculated in part (a). Why?

4.Donn Capp, the CFO, suspects that indirect labor costs, which the company has traditionally viewed as being variable, may actually be a mixed cost. In March 2016when the production volume was at a low of 15,000 units, the indirect labor cost was $4,000. In September 2016when production volume was at its highest level (40,000 units), the indirect labor cost was $9,000. What would be your estimate of the total indirect labor cost for the year under Plan A (i.e. for 390,000 units)? Assume the cost would be unaffected by inflation.