- 20 Marks
MA – L2 – Q70 – Performance analysis
Calculate the impact of three strategies on annual profit for Kumasi Ventures Ltd, each implemented independently.
Question
Kumasi Ventures Ltd manufactures and sells a single product. Its budget for the next financial year is as follows:
| Sales (80,000 units at GH₵600 per unit) | GH₵000 |
|---|---|
| 48,000 | |
| Production costs: materials and labour | 16,000 |
| Other production costs | 8,000 |
| Marketing and distribution costs | 12,000 |
| Administration costs | 10,000 |
| Total costs | 46,000 |
| Profit | 2,000 |
Materials and labour costs in production are 100% variable, and 25% of other production costs are variable. All administration costs are fixed costs and two-thirds of marketing and distribution costs are also fixed.
The directors of Kumasi Ventures Ltd are dissatisfied with the budgeted profit, and believe that annual profits should be at least double the size of the budgeted profit.
Three strategies have been proposed to improve profitability.
(1) Strategy 1. Increase sales by opening a new sales office in a neighbouring country. It is expected that this would increase annual sales by 5,000 units, but would add GH₵1.2 million to annual fixed costs.
(2) Strategy 2. Re-design the product by adding several additional features that should add value for the customer. This would have no effect on annual sales volume in units, but the company would be able to raise the sales price to GH₵625. The additional costs of producing the new product design would be GH₵1.5 million each year (all fixed costs).
(3) Strategy 3. Implement a cost reduction exercise throughout the company. It is expected that the planned exercise would reduce all variable costs by 20%, but would add to annual fixed costs by GH₵3.5 million.
Required:
(a) Calculate the effect of each individual strategy on annual profit, assuming that the strategy is implemented on its own, without the other two strategies.
(b) Show whether the three strategies, if they are all introduced together, will close the profit gap between the budgeted profit and the target profit that the directors would like to achieve.
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