SofTowel produces luxury towels for the hospitality industry. At the beginning of each year, the CEO together with marketing, production and financial managers discuss the operating business plan of the company. SofTowel is part of Wellness Consortium, which invested ￡2,500,000 and have requested a quarterly 10% return on investment (ROI). The bonus system is linked to these performance indicators. Currently SofTowel is functioning at the optimum production capacity of 75,000 towels/quarter. Beyond this volume, the fixed capacity costs are increased by ￡1,000 for each 5,000 extra units of finished products (towels). In order to produce one towel, SofTowel needs 1.5kg of pure cotton which is purchased at the price of
￡1.7/kg. The cotton is transported through a logistics company. The logistics company charges ￡3/kg plus a fixed sum for each transport of: ￡1,700 for any volume below 90,000kg (90 tonnes); ￡2,500 for 90,000-115,000kg (9-11.5 tonnes) and ￡3,500 for 115,001-150,000kg (11.5-15 tonnes). Normally the company purchases the direct material in one bulk to save on the fixed costs.
The production process begins with the setting up of the machines - one machine to treat the cotton and two weaving machines. There is the need for a team of three engineers, working 1.5 hours to set up the m for each cycle of production. The salary of each engineer is ￡25/hour. One standard production cycle processes 10,000 towels. The machine amortization charge is calculated at ￡5/towel. The production process is highly automated; hence, there is no need for any direct labour on the production line. At the end of the production process, the towels are sent for quality inspection. The inspection takes on average 6 minutes/towel and is performed by the quality department. The hourly wage for each quality inspector is ￡20/hour. Waste is negligible. After the inspection the towels are sent to the packing department where towels are wrapped and shipped.
The packing and transportation are calculated at ￡0.75/towel plus a fixed cost of ￡1,500/quarter, irrespective of production volume. SofTowel pays ￡45,000/quarter in rent and ￡20,000/quarter in administrative costs.
At the moment the business plan ascribes marketing efforts in relation to the following customer portfolio:
1. Novotel - 3 days of marketing work/quarter. Expected sales volume: 15,000 towels/quarter
2. Marriot - 3 days of marketing work/quarter. Expected sales volume: 20,000 towels/quarter
3. Hilton - 5 days marketing effort/quarter, extra effort on renegotiating the selling price. Expected sales volume: 25,000 towels/quarter
4. AccorHotels - 4 days marketing effort/quarter. Expected sales volume: 15,000 towels/quarter Marketing cost is considered as a cost of the period, as the Wellness Consortium is lending their marketing experts to SofTowel at ￡5,500 charge/day.
SofTowel agreed with the Wellness Consortium to use total cost plus a 20% markup to set up the selling prices of the towels.
The following opportunity is presented by SofTowel marketing manager:
Hoshino Resorts, a Japanese hotel chain, is searching for a new supplier. SofTowel has a very high chance to be the favourite option on the market. This business deal will represent the opening of the Asian market for SofTowel.
The marketing manager proposes to give up AccorHotels and instead to include Hoshino Resorts in the client portfolio. In order to win this client SofTowel needs to:
• Offer a selling price of ￡18.50/towel.
• Allocate approximately 5 days of marketing effort to get introduced to the client, conduct the negotiations and close the deal.
• Maintain the current price for Novotel and Marriot.
• Negotiate the selling price more aggressively for Hilton at ￡23/towel to cover the loss in quantity in the first semester. This means one day extra of marketing effort needs to be allocated to Hilton.
If the client is won by SofTowel, it will generate sales of 5,000 units for the first quarter and 20,000 units for each quarter to follow (Q2, Q3 andQ4). The CEO is excited by this new opportunity, but is afraid that SofTowel will not comply with the minimum price level (the 20% markup, established on the current set-up) and the target of ROI 10% quarterly.

Required

1. What is the per-unit selling price set-up (in accordance with full cost plus 20% markup agreement) and contribution margin of SofTowel under the current set-up?
2. Calculate the quarterly and yearly ROI with the current set-up.
3. Identify all relevant costs for the marketing manager's proposal. Provide arguments for each cost.
4. Calculate the quarterly ROI in the case that the marketing manager's proposal is accepted.
5. If you were the financial manager, what would you advise the CEO?