Two years ago, in conjunction with revitalization efforts regarding the downtown area of Metro City, you and your partner purchased a local eatery. Though moribund at the time, you were able (through your hard work and dedicated efforts) to resurrect the establishment. In fact, the last few months appear to have been quite successful from a financial standpoint.

However, your establishment now faces a new competitor-an eatery located only several blocks away from yours. You and your partner are now evaluating strategic options as to how to deal with this new competition. Your facility is capable of serving 200 meals a day. (Because your clientele consists almost exclusively of college-age students, the basic menu is the same for "lunch" and "dinner." Currently, your business does not serve breakfast.)

You and your partner have (finally!) taken time to "go over the books" (i.e., financial records) carefully. Your investigation yields the following information:

a. The primary variable cost is food (that is, the total food cost varies in response to changes in the number of meals served).

b. Fixed operating expenses (salaries, depreciation, etc.) average approximately $1,100 per day.

c. The average number of meals served per day over the past three months was 175. Given the above facts, and lacking any formal study of accounting, you calculate the budgeted fixed operating cost as $6.29 per meal (i.e., $1,100 4 175 meals per day). In response, in an attempt to fully recover your costs, you and your partner are contemplating a price increase.

Required

1. Given the competitive situation, what is the likely result of the decision to raise prices? Explain.

2. Suggest and defend an alternative approach for allocating budgeted fixed operating costs to each meal.