Question

The Rosa model of Mohave Corp. is currently manufactured as a very plain umbrella with no decoration. The company is considering changing this product to a much more decorative model by adding a silk-screened design and embellishments. A summary of the expected costs and revenues for Mohave’s two options follows:

	Rosa Umbrella			Decorated Umbrella
Estimated demand		21,000	units		21,000	units
Estimated sales price	$	23.00		$	33.00
Estimated manufacturing cost per unit
Direct materials	$	13.50		$	15.50
Direct labor		3.50			6.00
Variable manufacturing overhead		2.50			4.50
Fixed manufacturing overhead		4.00			4.00
Unit manufacturing cost	$	23.50		$	30.00
Additional development cost				$	10,000

Required:
1. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
2. Should Mohave add decorations to the Rosa umbrella?
3-a. Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 19,000 units. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
3-b. Should Mohave add decorations to the Rosa umbrella?

Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.

	Rosa Umbrella Decorated Umbrella Incremental Sales Revenue $483,000 $693,000 $210,000 Variable Costs Contribution Margin Additional Development Costs Differential Profit (Loss)

Answer 1

1)
	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue (21,000 units * $23); (21,000 * $33)	$483,000	$693,000	$210,000
Less: Variable costs:
Direct materials (21,000 * $13.50); (21,000*$15.50)	($283,500)	($325,500)	($42,000)
Direct labor (21,000 * $3.50); (21,000 * $6)	($73,500)	($126,000)	($52,500)
Variable manufacturing overheads (21,000 * $2.50); (21,000 * $4.50)	($52,500)	($94,500)	($42,000)
Contribution Margin	$73,500	$147,000	$73,500
Less: Fixed Costs:
Fixed manufacturing overheads (21,000*$4); (21,000 * $4)	($84,000)	($84,000)	$0
Additional development costs	$0	($10,000)	($10,000)
Differential Profit (Loss)	($10,500)	$53,000	$63,500
2) Yes, Mohave should add decorations to the Rosa Umbrella because the differential profit is increased from a loss of -$10,500 to a profit of $53,000 which shows an overall increase in profit by $63,500.
3-a)
	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue (21,000 units * $23); (19,000 * $33)	$483,000	$627,000	$144,000
Less: Variable costs:
Direct materials (21,000 * $13.50); (19,000*$15.50)	($283,500)	($294,500)	($11,000)
Direct labor (21,000 * $3.50); (19,000 * $6)	($73,500)	($114,000)	($40,500)
Variable manufacturing overheads (21,000 * $2.50); (19,000 * $4.50)	($52,500)	($85,500)	($33,000)
Contribution Margin	$73,500	$133,000	$59,500
Less: Fixed Costs:
Fixed manufacturing overheads (21,000*$4); (19,000 * $4)	($84,000)	($76,000)	$8,000
Additional development costs	$0	($10,000)	($10,000)
Differential Profit (Loss)	($10,500)	$47,000	$57,500
3-b) Yes, still Mohave should add decorations to the Rosa Umbrella because the differential profit is still increased from a loss of -$10,500 to a profit of $47,000 which shows an overall increase in profit by $57,500.