What is the maximum amount that the company should be prepared to pay for advertising?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Red Company is considering launching a new product which it believes has a 60% probability of success. The company is, however, considering undertaking an advertising campaign costing R60,000, which would increase the probability of success to 95%.
If successful the product would generate income of R220,000 otherwise R85,000 would be received.
What is the maximum amount that the company should be prepared to pay for advertising?
| A. |
R21,000 |
|
| B. |
R81, 000 |
|
| C. |
R39,000 |
|
| D. |
R47 250 |
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