Question

Required information

"Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability."

MSI’s educational products are currently sold without any supplemental materials. The company is considering the inclusion of instructional materials such as an overhead slide presentation, potential test questions, and classroom bulletin board materials for teachers. A summary of the expected costs and revenues for MSI’s two options follows:

	CD Only				CD with Instructional Materials
Estimated demand			44,000	units			44,000	units
Estimated sales price		$	28.00			$	55.00
Estimated cost per unit
Direct materials		$	3.00			$	3.25
Direct labor			3.50				6.50
Variable manufacturing overhead			3.50				6.75
Fixed manufacturing overhead			3.50				3.50
Unit manufacturing cost		$	13.50			$	20.00
Additional development cost						$	125,000

Required:
1. Based on the given data, compute the increase or decrease in profit that would result if instructional materials were added to the CDs.

	CD Only CD with Instructional Materials Incremental Sales Revenue Variable Costs Contribution Margin Additional Development Costs Differential Profit (Loss)

2. Should MSI add the instructional materials or sell the CDs without them?

3-a. Suppose that the higher price of the CDs with instructional materials is expected to reduce demand to 21,000 units. Complete the table given below based on Requirement 1 and 2 data.

	CD Only CD with Instructional Materials Incremental Sales Revenue Variable Costs Contribution Margin Additional Development Costs Differential Profit (Loss)

3-b. Should MSI add the instructional materials or sell the CDs without them?

Answer 1

1.

	CD only	CD with instructional material	Incremental
Sales revenue	$1,232,000	$2,420,000	$1,188,000
Variable cost	440,000	726,000	286,000
Contribution margin	792,000	1,694,000	902,000
Additional development cost		125,000	125,000
Differential profit (loss)	$792,000	1,569,000	777,000

2.

MSI should add instructional material.

3-a.

	CD only	CD with instructional material	Incremental
Sales revenue	$1,232,000	$1,155,000	-$77,000
Variable cost	440,000	346,500	93,500
Contribution margin	792,000	808,500	16,500
Additional development cost		125,000	-125,000
Differential profit (loss)	$792,000	$683,500	-$108,500

3-b. MSI should sell CDs without instructional materials.