Flat Rent or Revenue Share
A stationery shop's owner must choose a rent arrangement for the next twelve months. Last month the shop sold 1,200 notebooks at ₹80 each and 2,000 pens at ₹25 each. The shop's margin is 30% of the notebook's selling price and 40% of the pen's selling price. Salaries are ₹14,000 a month and utilities ₹4,000; rent under the present arrangement is ₹20,000. The landlord now offers two options. Option A: a flat rent of ₹26,000 a month, all other costs unchanged. Option B: no fixed rent, but 12% of total monthly revenue, all other costs unchanged. The owner expects volumes to fall by 10% next year if prices are held. The contract is for one year and cannot be renegotiated mid-term.
1. Compute the expected monthly profit under Option A and under Option B for next year, showing the margin figures you use.
Read the worked answer
Unit margins. Notebook: 30% of ₹80 = ₹24. Pen: 40% of ₹25 = ₹10.
Last month (check). Margin = 1,200 × 24 + 2,000 × 10 = 28,800 + 20,000 = ₹48,800. Costs = 20,000 + 14,000 + 4,000 = ₹38,000. Profit = ₹10,800. This anchors the model.
Next year, volumes down 10%. Notebooks 1,080; pens 1,800.
- Gross margin = 1,080 × 24 + 1,800 × 10 = 25,920 + 18,000 = ₹43,920.
- Revenue = 1,080 × 80 + 1,800 × 25 = 86,400 + 45,000 = ₹1,31,400.
Option A. Fixed costs = 26,000 + 14,000 + 4,000 = ₹44,000. Profit = 43,920 − 44,000 = −₹80 (a marginal monthly loss; about −₹960 for the year).
Option B. Landlord's share = 12% × 1,31,400 = ₹15,768. Other costs = 14,000 + 4,000 = ₹18,000. Total = ₹33,768. Profit = 43,920 − 33,768 = ₹10,152.
The gap is ₹10,232 a month, roughly ₹1.23 lakh a year - larger than one month's entire gross margin under Option A.
2. At what monthly revenue would the two options cost the shop the same amount? Interpret the figure against the shop's actual and projected revenue.
Read the worked answer
Set the total cost of each option equal, with R = monthly revenue:
- Option A cost = ₹44,000 (fixed, independent of R).
- Option B cost = ₹18,000 + 0.12R.
44,000 = 18,000 + 0.12R → 26,000 = 0.12R → R = ₹2,16,667 (approximately).
Interpretation:
- Current revenue is ₹1,46,000; projected revenue is ₹1,31,400. Option A is cheaper only above ₹2.17 lakh - about 48% above current revenue and 65% above the projected figure.
- Since the owner expects volumes to fall, Option A cannot become cheaper inside the contract year unless prices rise very sharply, which would push volumes down further.
- The comparison is also asymmetric in risk: under A the shop pays ₹26,000 whether it sells one notebook or a thousand; under B its rent bill shrinks with its sales. A is a bet on growth, B is insurance against decline.
Shortcut check: the crossover is where the fixed-rent premium (₹26,000) equals 12% of revenue, i.e. ₹26,000 ÷ 0.12. No margin information is needed for this step, which is why the answer does not depend on the product mix.
3. Recommend an option and state one non-numeric consideration that could legitimately override the arithmetic. Also state what would change your recommendation.
Read the worked answer
Recommendation: Option B. It yields about ₹10,152 a month against −₹80 under Option A on the owner's own forecast, and it protects against a worse year than forecast: if revenue halves to about ₹65,700, B's cost falls to about ₹25,900 while A stays at ₹44,000. Option A is not merely inferior, it is loss-making at the expected volume.
Non-numeric override. Option B hands the landlord a permanent right to inspect the shop's sales records, and it penalises exactly the growth the owner wants. If the owner has firm plans to add a high-margin line within the year, or if disclosing turnover to the landlord creates a dispute risk, A's certainty may be worth paying for - but only with a rent closer to ₹30,000–32,000 total, not ₹44,000.
What would flip the recommendation. (i) A credible forecast of revenue above ₹2.17 lakh a month; (ii) a negotiated Option A rent below ₹26,000 such that A's total cost drops under roughly ₹33,800; (iii) a cap or tapering clause on the 12% share. Absent one of these, choosing A would be paying a premium for a risk the shop cannot currently afford.