Sori Ltd. is a company engaged solely in the manufacture of jumpers which are bought mainly for sporting activities. The
current sales are direct to retailers, but in recent years there has been a steady decline in output because of increased
competition. In the last trading year (2020), the accounting report indicated that the company reported the lowest profit for
the last 10 years.
The forecast for 2021 indicates that the present deterioration in profits is likely to continue. The company considers that a
profit of Sh.8 million should be achieved to provide an adequate return on capital.
The managing director has asked that a review be made of the present pricing and marketing policies. The marketing
director has completed this review and passes the proposals to you for evaluation and recommendation, together with the
profit and loss account for the year ended 31 December 2020.
Sori Ltd. profit and loss account for the year ended 31 December 2020
| Sh."000" | Sh."000" | Sh."000" |
| Sales revenue (100,000 jumpers at Sh.1.000 per jumper) | | | 100,000 |
| Factory cost of goods sold: | | | |
| Direct materials | 10,000 |
| |
| Direct labour | 35,000 | | |
| Variable factory overheads | 6,000 | | |
| Fixed factory overheads | 22,000 | 73,000 |
|
| Administrative overheads | | 14,000 | |
| Selling and distribution overheads: | | | |
| Sales commission (2% of sales) | 2,000 | | |
| Delivery costs: | | | |
| Variable | 5,000 | | |
| Fixed | 4,000 | 11,000 | (98,000)
|
| Profit | | | 2,000 |
The information to be submitted to the managing director includes the following three proposals:
- To proceed on the basis of analysis of market research studies which indicate that demand for the jumpers is such
that a 10% reduction in selling price would increase demand by 40%.
- To proceed with an inquiry that the marketing director has had from a mail order company about the possibility of
purchasing 50,000 units annually if the selling price is right. The mail order company would transport the jumpers
from Sori Ltd. to its own warehouse and no sales commission would be paid on these sales by Sori Ltd. However,
if an acceptable price can be negotiated, Sori Ltd. would be expected to contribute Sh.6 million per annum towards
the cost of producing the mail order catalogue. It would also be necessary for Sori Ltd. to provide special
additional packaging at a cost of Sh.50 per jumper. The marketing director considers that in 2021, the sales from
existing business would remain unchanged at 100,000 jumpers based on a selling price of Sh.1,000 per jumper if
the mail order contract is undertaken
- To proceed on the basis of a view by the marketing director that a 10% price reduction, together with national
advertising campaign costing Sh.3 million may increase sales to the maximum capacity of 160,000 jumpers.
Required:
(a) Determine the break-even sales value based on the 2020 accounts.
(b) A financial evaluation of proposal (1) above and computation of the number of units Sori Ltd. would require to sell
to earn a target profit of Sh.8 million.
(c) Advise the management of Sori Ltd. on the minimum prices that would have to be quoted to the mail order
company to ensure that Sori Ltd. would at least break-even on the mail order contract.
(d) A financial evaluation of proposal 3.
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