Problem: Tennis Products, Inc., produces three models of high-quality tennis rackets. The following table contains recent information on th4e sales, costs, and profitability of the three models:
|
Model
|
Average Quantity Sold (Units/month)
|
Current Price
|
Total Revenue
|
Variable Cost per unit
|
Contribution margin per unit
|
Contribution Margin
|
|
A
|
15,000
|
$30
|
$450,000
|
$15.00
|
$15
|
$225,000
|
|
B
|
5,000
|
$35
|
$175,000
|
$18.00
|
$17
|
$85,000
|
|
C
|
10,000
|
$45
|
$450,000
|
$20.00
|
$25
|
$250,000
|
|
Total
|
|
|
$1,075,000
|
|
|
$560,000
|
The company is considering lowering the price of Model A to $27 in an effort to increase the number of units sold. Based on the results of price changes that have been instituted in the past, Tennis Products’ chief economist has estimated the arc price elasticity of demand to be -2.5. Furthermore, she has estimated the arc cross elasticity of demand between Model A and Model B to be approximately 0.5 and between Model A and Model C to be approximately 0.2. Variable costs per unit are not expected to change over the anticipated changes in volume.
Question 1: Evaluate the impact of the price cut on the (i) total revenue and (ii) contribution margin of Model A. Based on this analysis, should the firm lower the price of Model A?
Question 2: Evaluate the impact of the price cut on the (i) total revenue and (ii) contribution margin for the enter line of tennis rackets. Based on this analysis, should the firm lower the price of Model A?