Question 5

Hexagon Sounds owns a shop in London adjacent to its office in Shoreditch which it uses as an outlet for its vinyl LP records (it sells many more on-line). The shop carries a wide range of LP records that are all sold at the same price. Sales personnel in the shops are paid a substantial commission on each LP sold (in addition to a small basic salary) to encourage them to be aggressive in their sales efforts. Hexagon has estimated the following cost and revenue data for the shop:

	Per LP record
Sales price	30
Variable expenses:
Direct material	10
Direct labor	3.5
Sales commission	4.5
Total variable expenses	18
	Annual
Fixed expenses:
Manufacturing overhead	50,000
Salaries of sales staff	20,000
Advertising	30,000
Total fixed expenses	100,000

Tony Sherwood is anxious to improve the companys profit performance and has asked for several items of information.

1. Assume that the company produced and sold 10,000 LP records over the last year. Calculate the following:

1. Contribution margin per unit and Contribution margin ratio.

(2 marks)

2. Total profit or loss.

3. marks)

2. Calculate the annual break-even point in units and in pound sales for the shop and the margin of safety in percentage terms based on last years sales volume.

(6 marks)

3. Assume that next year management wants the shop to earn a profit of 66,000. How many LP records will have to be sold to meet this target profit figure?

4. marks)

d) Tony Sherwood believes that the current sales commission arrangement is not working and thinks that an increase in the basic salary might be better for profits (as well as staff motivation) in the coming year. Assuming sales next year of 12,000 LPs calculate whether a one-third increase in the sales commission per unit or a doubling of basic salaries would lead to higher profits. What advice would you give to Tony?

(8 marks)

5. Tony vaguely recalls from his Business Management degree that the concept of price elasticity of demand can help to determine the optimal size of the mark-up to apply when determining the price for a product. He temporarily reduces the price of an LP from 30 to 24 and finds that the quantity sold rises by 30%. Using this information, calculate the profit-maximising price for an LP. Explain to Tony the potential issues with using this approach to pricing.

(8 marks)

6. On-line sales of LPs have increased in importance for Hexagon Sounds. Assuming that on-line sales eliminate the need for sales commissions and sales staff salaries entirely, but double the advertising cost, what price would be needed to generate a profit of 80,000?

(4 marks)