Alternate cost structures, uncertainty, and sensitivity analysis. Edible Bouquets (EB) makes and sells flower bouquets. EB is considering opening a new store in the local mall. The mall has several empty shops and EB is unsure of the demand for its product. The mall has offered EB two alternative rental agreements. The first is a standard fixed-rent agreement where EB will pay the mall $5,000 per month. The second is a royalty agreement where the mall receives $10 for each bouquet sold. EB estimates that a bouquet will sell for $50 and have a variable cost of $30 to make (including the cost of the flowers and commission for the sales-person).
1. What is the breakeven point in units under each assumption?
2. For what range of sales levels will EB prefer (a) the fixed-rent agreement and (b) the royalty agreement?
3. If EB signs a sales agreement with a local flower stand, it will save $5 in variable costs per bouquet. How would this affect your answer in requirement 2?
4. EB estimates that the store is equally likely to sell 200, 400, 600, 800, or 1,000 arrangements. Using information from the original problem, prepare a table that shows the expected profit at each sales level under each rental agreement. What is the expected value of each rental agreement? Which rental agreement should EB choose?