Question

Johnson and Gomez, Inc. is a small firm involved in the production and sale of electronic business products. The company is well known for its attention to quality and innovation.

During the past 15 months, a new product has been under development that allows users improved access to e-mail and video images. Johnson and Gomez code named the product the Wireless Wizard and has been quietly designing two models: Basic and Enhanced. Development costs have amounted to $189,000 and $270,000, respectively. The total market demand for each model is expected to be 45,000 units, and management anticipates being able to obtain the following market shares: Basic, 20 percent; Enhanced, 15 percent. Forecasted data follow.

	Basic				Enhanced
Projected selling price	$	370.00			$	470.00
Per-unit production costs:
Direct material		47.00				75.00
Direct labor		25.00				35.00
Variable overhead		41.00				53.00
Marketing and advertising (fixed but avoidable)		200,000				325,000
Sales commissions*		15	%			20	%

*Computed on the basis of sales dollars.

Since the start of development work on the Wireless Wizard, advances in technology have altered the market somewhat, and management now believes that the company can introduce only one of the two models. Consultants confirmed this fact not too long ago, with Johnson and Gomez paying $35,000 for an in-depth market study. Sales salaries (excluding commission) will be $88,000 no matter which product is sold. The marketing and advertising costs indicated for each product are incurred only if that product is sold. Other fixed overhead is expected to be the same, regardless of which product is introduced.

1. Compute the unit contribution margin for both models. (Round your answers to 2 decimal places.)

3-a. Prepare a financial analysis and determine which of the two models should be introduced.

What other factors should Johnson and Gomez, Inc. consider before a final decision is made?

• Possibility of merger of the firm with a bigger player
• Growth potential of the Basic and Enhanced models
• Competitive products in the marketplace
• Aesthetic differences between the two products
• Break-even points
• Data validity
• Previous years' sales trends
• Production feasibility
• Effects, if any, on existing product sales

Answer 1

Part 1

	Basic		Enhanced
Selling price		370		470
Less: variable costs:
Direct materials	47		75
Direct labor	25		35
Variable manufacturing overhead	21		53
Sales commission (370*15%); (470*15%)	55.50		70.5
Total unit variable cost		148.50		233.50
Unit contribution margin		$221.50		$236.50

Part 3

	Basic	Enhanced
Total contribution margin (45000*20%*221.50); (45000*15%*236.50)	1993500	1596375
Less: marketing and advertising	200000	325000
Income	$1793500	$1271375

Basic model should be introduced as it gives higher income.

Important factors are as follows:

Competitive products in the marketplace

Data validity

Growth potential of the Basic and Enhanced models

Production feasibility

Effects, if any, on existing product sales

Break-even points