A Hotel Order That May Not Be Worth Taking
A young entrepreneur makes paper bags in a semi-urban area. Monthly fixed costs are rent ₹4,000, electricity ₹800, and machine EMI ₹1,200. Variable cost is ₹1.20 per bag, and the selling price to retail shops is ₹3.00 per bag. Current sales are 4,000 bags per month, all paid in cash. A hotel offers 6,000 bags per month at ₹2.10 per bag, but requires 45-day credit and delivery penalties for late supply. The existing machine can make 5,000 bags per month. To serve the hotel, the entrepreneur must hire one worker at ₹8,000 per month and add a machine on EMI of ₹1,500 per month, raising capacity to 10,000 bags. The entrepreneur has ₹15,000 in working capital. Retail demand is steady and will not grow in the next six months.
1. Calculate current monthly profit and the break-even quantity at the retail price. Show contribution per bag.
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Contribution per bag = selling price − variable cost = ₹3.00 − ₹1.20 = ₹1.80. Current monthly sales = 4,000 bags, so total contribution = 4,000 × ₹1.80 = ₹7,200. Fixed costs = rent ₹4,000 + electricity ₹800 + machine EMI ₹1,200 = ₹6,000. Current profit = ₹7,200 − ₹6,000 = ₹1,200 per month. Break-even quantity = fixed costs ÷ contribution per bag = ₹6,000 ÷ ₹1.80 = 3,333.33 bags. Since bags are whole units, the break-even is 3,334 bags per month. At 4,000 bags the entrepreneur is only 666 bags above break-even, so a small fall in retail demand would wipe out profit.
2. Calculate the incremental monthly profit or loss from accepting the hotel order at ₹2.10, including the new worker and machine EMI. State whether the order should be accepted on financial grounds alone.
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Hotel order contribution = ₹2.10 − ₹1.20 = ₹0.90 per bag. For 6,000 bags, contribution = ₹5,400. Additional fixed costs = worker ₹8,000 + new machine EMI ₹1,500 = ₹9,500. Incremental result = ₹5,400 − ₹9,500 = −₹4,100 per month. On financial grounds alone, the order should be rejected because it reduces monthly profit from +₹1,200 to −₹2,900 (₹1,200 − ₹4,100). Capacity is not the problem: 4,000 retail + 6,000 hotel = 10,000 bags, exactly the new capacity, so any disruption would also hurt retail supply. The 45-day credit ties up 6,000 × ₹2.10 = ₹12,600, which is most of the ₹15,000 working capital. The order is too risky at ₹2.10.
3. The hotel refuses to raise the price. Identify the minimum price per bag that would make the order break even incrementally, and discuss one non-price condition the entrepreneur should negotiate before accepting.
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To cover the additional fixed costs, the hotel price must satisfy: (price − ₹1.20) × 6,000 = ₹9,500. Price − ₹1.20 = ₹9,500 ÷ 6,000 = ₹1.5833. Minimum price = ₹1.20 + ₹1.5833 = ₹2.7833, so about ₹2.79 per bag. At ₹2.79 the order merely breaks even before any credit cost; the entrepreneur should ask for a little more to cover the 45-day financing and delivery-penalty risk. A non-price condition to negotiate is reducing credit to 15–20 days or agreeing part payment on delivery. That lowers working-capital exposure. The entrepreneur could also ask the hotel to accept a smaller trial order first, so capacity and quality are tested before hiring a worker and adding a machine.