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.

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.

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

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 = $____________________________

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.

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

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?