3 The directors of The Healthy Eating Group (HEG), a successful restaurant chain, which commenced trading in 1998,

have decided to enter the sandwich market in Homeland, its country of operation. It has set up a separate operation

under the name of Healthy Sandwiches Co (HSC). A management team for HSC has been recruited via a recruitment

consultancy which specialises in food sector appointments. Homeland has very high unemployment and the vast

majority of its workforce has no experience in a food manufacturing environment. HSC will commence trading on

1 January 2008.

The following information is available:(1) HSC has agreed to make and supply sandwiches to agreed recipes for the Superior Food Group (SFG) which

owns a chain of supermarkets in all towns and cities within Homeland. SFG insists that it selects the suppliers

of the ingredients that are used in making the sandwiches it sells and therefore HSC would be unable to reduce

the costs of the ingredients used in the sandwiches. HSC will be the sole supplier for SFG.(2) The number of sandwiches sold per year in Homeland is 625 million. SFG has a market share of 4%.(3) The average selling price of all sandwiches sold by SFG is $2·40. SFG wishes to make a mark-up of 331/3% on

all sandwiches sold. 90% of all sandwiches sold by SFG are sold before 2 pm each day. The majority of the

remaining 10% are sold after 8 pm. It is the intention that all sandwiches are sold on the day that they are

delivered into SFG’s supermarkets.(4) The finance director of HSC has estimated that the average cost of ingredients per sandwich is $0·70. All

sandwiches are made by hand.(5) Packaging and labelling costs amount to $0·15 per sandwich.(6) Fixed overheads have been estimated to amount to $5,401,000 per annum. Note that fixed overheads include

all wages and salaries costs as all employees are subject to fixed term employment contracts.(7) Distribution costs are expected to amount to 8% of HSC’s revenue.(8) The finance director of HSC has stated that he believes the target sales margin of 32% can be achieved, although

he is concerned about the effect that an increase in the cost of all ingredients would have on the forecast profits(assuming that all other revenue/cost data remains unchanged).(9) The existing management information system of HEG was purchased at the time that HEG commenced trading.

The directors are now considering investing in an enterprise resource planning system (ERPS).

Required:(a) Using only the above information, show how the finance director of HSC reached his conclusion regarding

the expected sales margin and also state whether he was correct to be concerned about an increase in the

price of ingredients. (5 marks)