Question

EXERCISE 5

Clear View, a manufacturer of an inexpensive line of tablets, distributes its products to large retailers. The product line consists of three models of tablets:

Model       Selling Price/Unit   Variable Cost/Unit   Demand/Year
           (price to retailers)               (units)

Model A   $350           $200           2,000
Model B   $500           $250           1,000
Model C   $600           $280           500

Clear View is considering adding a fourth model to the product line. This model would be sold to retailers for $750. The variable cost of this unit is $450. The demand on this new Model D is estimated to be 300 units per year.

Sixty percent of these unit sales of the new model are expected to come from other models already being manufactured by Clear View (10% from Model A, 30% from Model B, and 60% from Model C).

Clear View will incur a fixed cost of $40,000 to add the new model to the product line. Based on the preceding data, should Clear View add the new Model D? Explain your rationale.

Answer 1

Solution:

The contribution = Revenue - variable cost

Case 1 )

When the company has 3 models A , B and C.

The income from model A , B and C are 710,000

Case 2 )

When the company introduces model D. This impacts the sale of existing model. After considering this impact we can see that the income is = 749,240 without considering fixed cost and when we consider the fixed cost then the income = 709,240.

So, If this fixed cost is applicable for only 300 quantity of model D then the company is getting less income (709,240 against 710,000).

So the company should not launch model D.

But if this fixed will be spread for many years then the company has advantage of launching the model D as contribution is higher ( not considering the fixed cost) than the first case.