A brewer is launching a new product; brewed ginger ale with a low alcohol content. The brewer plans to spend $ 3 million promoting this product this year, which is expected to expand its sales of this product to $ 11 million this year and $ 8 million next year. They do expect there will be loss of sales of $ 3 million this year and next year in their other products as customers switch to drinking the new ginger ale. The gross profit margin for the new ginger ale is 40%, the gross profit margin of all of the brewer's other products is 30%, and the brewer's marginal corporate tax rate is 35%. What are incremental earnings arising from the promotional campaign this year?

Sales - $11m

Gross Profit = $4.4m

Promotion costs = $3m

Loss of Profit = $0.9m

Net Income = $0.5m

Income Tax = $0.175m

Incremental Earnings = $0.325m

Explanation:

a) Promotion cost of $3m spent this year is also charged to income for the period.

b) The loss of sales of $3m this year will result to a loss of profit calculated as follows:

Gross profit of sales of $3m x 30%  = $0.9m.

c) Incremental earnings are the increases in earnings attributed to the promotional campaign.

d) Gross profit for the ginger ale is equal to 40% of sales, that is 40% of $11m = $4.4m.  It is from this profit that incremental costs are deducted to obtain the incremental earnings.

e) The Income Tax = 35% of the Net Income.  The actual net income will be less than the above because there will be other deductible expenses and the lost sales will not be taken into account for the purpose of deriving the net income.

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