Sensitivity and inflation. As chairman of Walk-About, you are concerned that inflation may squeeze

Sensitivity and inflation.

As chairman of Walk-About, you are concerned that inflation may squeeze your profitabil- ity. Specifically, you feel committed to the £30 selling price, and fear that lowering the quality of the shoes in the face of rising costs would be an unwise marketing move. You expect the cost of shoes to rise by 10% during the coming year. You are tempted to avoid the cost increase by placing a non-cancellable order with a large supplier that would pro- vide 50 000 units of the specified quality for each store at £19.50 per unit. (To simplify this analysis, assume that all stores will face identical demands.) These shoes could be acquired and paid for as delivered throughout the year. However, all shoes must be delivered to the stores by the end of the year.

As a shrewd merchandiser, you foresee some risks. If sales were less than 50 000 units, you feel that markdowns of the unsold merchandise would be necessary to sell the goods. You predict that the average selling price of the leftover units would be £18.00. The regular commission of 5% of revenues would be paid to salespeople.

Required

1 Suppose that actual sales at £30 for the year is 48 000 units and that you contracted for

50 000 units. What is the operating profit for the store?

2 If you had perfect forecasting ability, you would have contracted for 48 000 units rather than 50 000 units. What would the operating profit have been if you had ordered 48 000 units?

3 Given actual sales of 48 000 units, by how much would the average cost per unit have had to rise before you would have been indifferent between having the contract for

50 000 units and not having the contract?