Chapter 11, Problem 2P

Hau Lee Furniture, Inc., described in Example 1 of this chapter, finds its current profit of $10,000 inadequate. The bank is insisting on an improved profit picture prior to approval of a loan for some new equipment. Hau would like to improve the profit line to $25,000 so he can obtain the bank’s approval for the loan.

a) What percentage improvement is needed in the supply chain strategy for profit to improve to $25,000? What is the cost of material with a $25,000 profit?

b) What percentage improvement is needed in the sales strategy for profit to improve to $25,000? What must sales be for profit to improve to $25,000?

Summary Introduction

To determine: The material cost and percentage change in material cost using supply chain strategy for a profit of $25,000 in Company HL.

Introduction: Supply chain management is one of the important elements of a business which impacts business product development. With expanding business in global conditions, supply chain activities can impact on the cost effectiveness of the business.

Answer to Problem 2P

Using supply chain strategy 25% decrease in material cost is required to yield profit of $25,000.

Explanation of Solution

Given information:

Particulars	Amount	Percentage
Sales	$100,000
Material cost	$60,000	60%
Production cost	$20,000	20%
Fixed cost	$10,000	10%
Profit	$10,000	10%

Supply chain strategy:

Supply chain strategy	Amount	Percentage increase or decrease
Sales	$100,000
Material cost	$45,000	-25%
Production cost	$20,000	0%
Fixed cost	$10,000	0%
Profit	$25,000	150%

Calculation of percentage changes using supply chain strategy:

Company HL estimates to increase its profit from $10,000 to $25,000.

Percentage of material cost for profit of $25,000:

$\begin{array}{c}\text{Profit}=\left[\begin{array}{l}\text{Sales}-\left(\text{Sales}\times {\text{Percentage}}_{\text{Material cost}}\right)-\\ \left(\text{Sales}\times {\text{Percentage}}_{\text{Production cost}}\right)-\text{Fixed cost}\end{array}\right]\\ \text{\$25,000}=\left[\begin{array}{l}\text{\$100,000}-\left({\text{\$100,000×Percentage}}_{\text{Material}}\right)-\\ \left(\text{\$100,000}\times \frac{\text{20}}{\text{100}}\right)-\text{\$10,000}\end{array}\right]\\ \text{\$25,000}=\text{\$100,000}-\left(\text{\$100,000}\times {\text{Percentage}}_{\text{Material}}\right)-\text{\$30,000}\\ \text{\$25,000}=\text{\$70,000}-\left(\text{\$100,000}\times {\text{Percentage}}_{\text{Material}}\right)\end{array}$

$\begin{array}{c}\left({\text{\$100,000×Percentage}}_{\text{Material}}\right)=\text{\$70,000}-\text{\$25,000}\\ {\text{Percentage}}_{\text{Material}}=\frac{\text{\$45,000}}{\text{\$100,000}}\\ =\text{45\%}\end{array}$

For an expected profit for $25,000 from $10,000, the estimated percentage of material cost is 45%.

Material cost for an expected profit $25,000:

$\begin{array}{c}\text{Sales}=\text{\$100,000}\\ \text{Material}\text{cost}=\text{45\%}\text{of}\text{sales}\\ =\frac{\text{45}}{\text{100}}\times \text{100,000}\\ =\text{\$45,000}\end{array}$

Percentage change in material cost for an expected profit $25,000:

$\begin{array}{c}\text{Change in percentage}=\frac{\text{Material}{\text{cost}}_{\text{current}}-\text{Material}{\text{cost}}_{\text{initial}}}{\text{Material}{\text{cost}}_{\text{initial}}}\times 100\\ =\frac{\$45,000-\$60,000}{\$60,000}\times 100\\ =-25\%\end{array}$

The material cost decreased by 25%.

Change in profit percentage:

$\begin{array}{c}\text{Change in profit percentage}=\frac{{\text{Profit}}_{\text{Current}}-{\text{Profit}}_{\text{inital}}}{{\text{Profit}}_{\text{Initial}}}\times 100\\ =\frac{\$25,000-\$10,000}{\$10,000}\times 100\\ =\frac{\$15,000}{\$10,000}\times 100\\ =1.5\text{or}150\%\end{array}$

The percentage change in profit, when profit rises from $10,000 to $25,000 is 150%.

Hence, by using supply chain strategy 25% decrease in material cost is required to yield profit of $25,000.

Summary Introduction

To determine: The sales and percentage change in sales using sales strategy for a profit of $25,000 in Company HL.

Answer to Problem 2P

Using sales strategy 75% increase in sales is required to yield profit of $25,000.

Explanation of Solution

Given information:

Particulars	Amount	Percentage
Sales	$100,000
Material cost	$60,000	60%
Production cost	$20,000	20%
Fixed cost	$10,000	10%
Profit	$10,000	10%

Sales Strategy:

Sales strategy	Amount	Percentage increase or decrease
Sales	$175,000	75%
Material cost	$105,000 (60%)	75%
Production cost	$35,000(20%)	75%
Fixed cost	$10,000	0%
Profit	$25,000	150%

Calculation of percentage changes using sales strategy:

Calculate the percentage increase in the sales:

$\begin{array}{c}\text{Profit}=\text{Sales}-\left(\text{Sales}\times {\text{Percentage}}_{\text{Material cost}}\right)-\left(\text{Sales}\times {\text{Percentage}}_{\text{Production cost}}\right)-\text{Fixed cost}\\ \$25,000=\text{Sales}-\left(\text{Sales}\times \text{0}\text{.6}\right)-\left(\text{Sales}\times 0.2\right)-\$10,000\\ \$25,000=0.2\text{Sales}-\$10,000\\ 0.2\text{Sales}=\$10,000+\$25,000\\ \text{Sales}=\frac{\$35,000}{0.2}\\ =\$175,000\end{array}$

Sales increase to $175,000 when profit is $25,000.

Change in material cost:

$\begin{array}{c}\text{Material}{\text{cost}}_{\text{current}}=\text{60\%Sales}\\ =\frac{\text{60}}{\text{100}}\times \text{\$175,000}\\ =\text{\$105,000}\end{array}$

For an estimated profit of $25,000, the sales changes to $175,000 and hence due to change in sales there is also change in material cost. Material cost is 60% of sales. Therefore for sales of $175,000, the material cost is $105,000.

Percentage change in material cost:

$\begin{array}{c}\text{Change in percentage}=\frac{{\text{Material cost}}_{\text{Current}}-{\text{Material cost}}_{\text{Initial}}}{{\text{Material cost}}_{\text{Initial}}}\\ =\frac{\$105,000-\$60,000}{\$60,000}\times 100\\ =\frac{\$45,000}{\$60,000}\times 100\\ =75\%\end{array}$

The percentage change in material cost is 75% when the sales increase to $175,000.

Change in production cost:

$\begin{array}{c}\text{Production}{\text{cost}}_{\text{current}}=2\text{0\%Sales}\\ =\frac{\text{20}}{\text{100}}\times \text{\$175,000}\\ =\text{\$35,000}\end{array}$

For an estimated profit of $25,000, the sales changes to $175,000 and hence due to change in sales there is also change in production cost. Production cost is 20% of sales. Therefore for sales of $175,000, the production cost is $35,000.

Percentage change in production cost:

$\begin{array}{c}\text{Change in percentage}=\frac{{\text{Production cost}}_{\text{Current}}-{\text{Production cost}}_{\text{Initial}}}{{\text{Production cost}}_{\text{Initial}}}\\ =\frac{\$35,000-\$20,000}{\$20,000}\times 100\\ =\frac{\$15,000}{\$20,000}\times 100\\ =75\%\end{array}$

The percentage change in production cost is 75% when the sales increase to $175,000.

Change in sales percentage:

$\begin{array}{c}\text{Change in sales percentage}=\frac{{\text{Sales}}_{\text{Current}}-{\text{Sales}}_{\text{inital}}}{{\text{Sales}}_{\text{Initial}}}\\ =\frac{\$175,000-\$100,000}{\$100,000}\\ =\frac{\$75,000}{\$100,000}\\ =0.75\text{or}75\%\end{array}$

The percentage change in sales, when profit rises from $10,000 to $25,000 is 75%.

Hence, by using sales strategy 75% increase in sales is required to yield profit of $25,000.