ECON001B - Microeconomics

Homework - Cost Analysis Using Accounting and Economic Techniques

24/7 Summer Online Class: ----Due: Tuesday, July 23rd, 2019

This Homework Assignment Will Need To Be Emailed To Me In CANVAS Since

CONNECT Can't Handle Excel Based Homework

Goal:

Please answer the questions below. The main goal of this homework is to see if you can calculate

the profit maximization point for this small wedding cake business. I hope that you will be able

to merge your knowledge of basic accounting and microeconomic theory in order to calculate the

profit maximization point, make comments about efficiency, and make logical recommendations

to the firm's management to ensure their future success.

Current Situation:

The local wedding cake business was very competitive during 2012.

Delicious Deserts

was the

only wedding cake bakery in the entire county of two million people for several years. They

often charged as much as $300 to $500 for each wedding cake. But a new competitor recently

came into the market and started selling "discount wedding cakes" for less than $150. The

quality and the taste of the discount wedding cakes were acceptable for most of their customers.

Both businesses operated in a low-to moderate-income county in California where the average

household income was not much higher than $40,000 per year.

The Challenge For Delicious Deserts:

At first the news of a low-cost competitor was terrible news for Delicious Deserts. They had no

choice. They had to charge from $300 to $500 per wedding cake to cover their high costs.

However, because of this new competition, the husband and wife owners of Delicious Deserts

decided to make the business more efficient and lower costs. They invested in better ovens and

created better tasting cakes using special ingredients. Their customers went crazy over their new

and unique 80 proof Italian Rum Wedding cake that actually got people slightly drunk if they ate

more than three slices.

To boost sales during 2012 they hired part-time telemarketers and social media experts. They

also increased their advertising in traditional media such as local wedding magazines. They also

displayed eye-catching ads in local churches, entertainment centers and jewelry stores.

They also experimented with a new pricing model in which they lowered prices each quarter.

Indeed, they found that as they lowered their prices, they sold more cakes. They hired an "A"

student who took a microeconomics class with Professor Ed Torres to do an elasticity analysis.

The student estimated that the price elasticity for wedding cakes was 1.25 (elastic) and that the

income elasticity was 2.10 (a luxury good). The owners of Delicious Deserts were not aware of

this information. The student told them that they made a huge pricing strategy error for many

years by charging high prices on an elastic good within a low-to moderate-income county.

2

The profit and loss statement below shows that Delicious Deserts made a Total Revenue of

$275,000 and sold 1,375 wedding cakes. During 2012, they made three times (3X) more than

they did versus 2011. Of course, because they invested in new ovens, made more cakes, and

hired new part-time staff, the cost of doing business also rose. The net profit for 2012 was a slim

$32,175. The salary for a professional desert baker averaged $70,000 per year in California.

Please examine the profit and loss statement on the next page, then answer the questions on

pages 4 through 6.

3

Delicious Deserts, Incorporated

Income Statement For The Year Ending December 31, 2012

Revenues

Gross Sales....................................................................$275,000

Less: Sales Discounts ..................................................$ 2,500

Less: Returns (Cancelled Weddings)...........................$ 2,000

Net Sales...............................................................................................$270,500

Cost of Goods Sold

Beginning Inventory (January 1).................................$ 18,000

Cost Of Ingredients To Bake Cakes............................$109,500

Total Cost of Goods For Sale......................................$127,500

Less: Ending Inventory December 31.........................$ 15,000

Cost

of Goods Sold..............................................................................$112,500

Gross Profit.....................................................................................................$158,000

Operating Expenses

Selling Expenses

Sales Commissions........................................$ 31,000

Advertising...................................................$ 16,000

Other Selling Expenses (Internet).................$ 18,000

Total Selling Expenses...............................................$ 65,000

General and Administrative Expenses

Professional & Office Salaries.................................$ 20,500

Utilities....................................................................$ 5,000

Office Supplies........................................................$ 1,500

Bank Interest Paid on Loans....................................$ 3,600

Insurance.................................................................$ 2,500

Rent (Fixed Cost)....................................................$ 17,000

Total General & Administrative Expense.............................$ 50,100

Total Operating Expenses..................................................$115,100

Net Profit Before Taxes..............................................................................$ 42,900

Less: Federal/State/Local Taxes................................................................$ 10,725

NET PROFIT.............................................................................................$ 32,175

4

Question #1:

What was the Total Fixed Cost of running this business?

Free Answer:

The rent was the only fixed cost that Delicious Deserts had. They paid $17,000 per year or

$1,416.66 per month for rent. All other expenses were variable costs.

Question #2:

What was the Total Variable Cost of running this business?

Answer: $________________________________________

Clue:

Add up Cost of Goods Sold, Total Operating Expenses (less Rent), Income Tax Expense and

include the write-off losses from Sales Discounts & Wedding Cancellations.

Question #3:

Assuming that Delicious Deserts sold 150 cakes during Q1, 300 cakes during Q2, 450 cakes

during Q3, and 475 cakes during Q4, what was the Total Revenue during each quarter

assuming the prices were: Q1 - $275 per cake, Q2 - $240 per cake, Q3 - $180 per cake and

Q4 - $170 per cake?

Q1 - Total Revenue = $____________________________

Q2 - Total Revenue = $____________________________

Q3 - Total Revenue = $____________________________

Q4 - Total Revenue = $____________________________

5

The "A" student did a quarterly cost breakdown analysis for Delicious Deserts. A month-to-

month analysis would have been better, but the owners just wanted a quick quarterly analysis.

Q1 = 150 cakes sold, Q2 = 300 cakes sold, Q3 = 450 cakes sold and Q4 = 475 sold.

Challenge Question #4:

Using the instructions on page 7 of the Excel 2007 handout, can you plot a nice looking

graph to show how the demand curve, the average total cost, marginal cost, and marginal

revenue curves look like? Paste it on this page or attach a separate page to this homework.

Quantity Sold

0

150

300

450

475

Demand/Price

$275

$275

$240

$180

$170

MR

$275

$205

$ 60

($ 10)

ATC

$238

$207

$153

$151

MC

$200

$175

$ 47

$283

TR

$41250

$72000

$81000

$80750

TC

$35750

$62000

$69000

$76075

Net Profit

$ 5500

$10000

$12000

$ 4675

6

Question #5

What is the MC=MR Profit Maximization point? What quantity should Delicious Deserts

be producing at 'and' what price should they be charging to maximize their profits?

Question #6

Why isn't it a good idea for them to produce and sell as many cakes as they can? Is it more

profitable to sell less cakes at this current stage of their business?

Question #7

Do you have any other recommendations for Delicious Deserts to increase their revenues,

profits, market share, and client retention?