You currently sell 50,000 units of a product for $40 each. The unit variable cost of producing the product is $5. You are thinking of cutting the product price by 30% because you are confident that this drop in price will increase sales by an amount of 10% through 50%. Perform a sensitivity analysis to show how profit will change as a function of the percentage increase in sales. Ignore fixed costs.

Answer and Explanation:

The sensitivity analysis here would try to find out the different values that would emerge as we input the different values to determine it's impact on revenue.

From the above

Initial selling price=$40

Cost price=$5

Initial profit=$35

Product price slash/new price=0.30 (30%) * 40=$12 = $28 in new price

Initial sales in units = 50000 units

Initial revenue = 50000*$40=$2000000

Initial profit=$2000000 - ($250000) = $1750000

New sales in units for 10% increase = 0.10 (10%) * 50000=5000 which will equal 55000 units

New sales in units for 50% increase=0.50 (50%) * 50000=25000=75000 units

New revenue for 10% sales increase and slashed price=$1540000 (55000*$28)

New revenue for 50% sales increase and slashed price=$2100000 (75000*$28)

From the above, we can see price slash has greatly affected revenue negatively. The price decrease means lower revenue than initial revenue even for a 10% increase in sales (this is before cost of $5 has been accounted for. Also under the 50% increase in sales we can only observe a 5% increase in revenue but this is false as we are yet to account for cost of production. This is also under the assumption that fixed cost is non existent. Therefore it would be best that the initial price is stuck to, or maybe a much lower decrease in price would be advised.