Problem 3: Supreme Vacuum Cleaner Company

The Supreme Vacuum Cleaner Company produces and sells three different types of upright vacuum cleaners: (1) the F1, (2) the F3, and (3) the F5. Each vacuum cleaner shares certain basic features such as a 15-inch cleaning width, edge groomers, headlight, and 31-foot power cord. However, the vacuums differ in the power offered (the F5 has a 12-amp motor and dual agitators), versatility (the F5 comes with five cleaning tools, whereas the F3 comes with three cleaning tools and the F1 has only one cleaning tool), and ease of use (both the F3 and the F5 are manufactured without belt drivesthus, customers do not need to purchase or install a replacement belt as they ultimately would have to for the F1).

Management of Supreme has provided you with the following data for their most recent year of operations:

Vacuum Cleaner

F1

F3

F5

Selling price per unit

$250

$150

$300

Variable cost per unit

$100

$90

$150

Quantity sold

25,000

15,000

10,000

In addition, management has informed you that annual fixed costs amounted to $4,500,000.

Required:

a.What was Supreme's profit for the most recent year?

b.Assume that Supreme wants to spend $300,000 on advertising. To maximize impact, management believes it should focus all advertising dollars on one of the three vacuum cleaners. Regardless of the product chosen, Supreme estimates that sales of the targeted vacuum cleaner will increase by $800,000, whereas sales for each of the other two vacuum cleaners are expected to decrease by $100,000. Which vacuum cleaner should be the focus of the advertising campaign? By how much is profit expected to increase as a result of the advertising campaign?

c.In part (b), Supreme's management assumed that, regardless of the product chosen for the advertising campaign, the increase in sales revenue will be constant at $800,000. What assumption is management making? Likewise, management also assumed that the decline in sales revenue associated with the two vacuum cleaners not selected for the advertising campaign will be constant at $100,000. Do you believe these assumptions accurately depict reality? Why?