Question

Video Concepts Inc. (VCI) manufactures a line of DVD recorders that it distributes to mass market retail chains. VCI has three products in its line, LX1, LX2, and LX3. LX1 sells for $175 with a contribution margin (CM) of 43%. LX2’s contribution is equal to its variable cost at $125. LX3’s $160 contribution represents 53% of its price. Annual forecasts for LX1, LX2, and LX3 are 2000 units, 1000 units, and 500 units, respectively.

VCI is considering adding a higher priced model, LX4 with a variable cost of $225 against a price of $375. Demand is estimated to be 300 units per year. 60% of unit sales will probably be cannibalized from VCI’s existing line, as follows: 10% from LX1, 30% from LX2, and 60% from LX3. The rest will be taken from competition.

Given a required investment of $20,000 to launch LX4, would you recommend this project? Please fully explain why, or why not.

Answer 1

Interpretation of data from the question

Model	DVD selling price per unit	Variable cost per unit	Demand per year	Total contribution
LX1	175	175 - 175*.43 = 99.75 rounded off to 100	2000	(175-100)*2000 =150000
LX2	125+125 = 250	125	1000	125*1000 = 125,000
LX3	160/0.53 = 302	302-160 = 142	500	(302-142)*500 = 80,000
Total				355,000

Contribution after adding new model LX4

60% of unit sales (300*0.6=180) of the new model comes from:

10% from LX1 : 180*0.1=18 units

30% from LX2 : 180*0.3=54 units

60% from LX3 : 180*0.6=108 units

Model	DVD selling price per unit	Variable cost per unit	Demand per year	Total contribution
LX1	175	175 - 175*.43 = 100	2000-18 = 1982	(175-100)*1982 = 148650
LX2	125+125 = 250	125	1000-54 = 946	125*946 = 118,250
LX3	160/0.53 = 302	302-160 = 142	500-108 = 392	(302-142)*392 = 62720
LX4	375	225	300	45000
Total				374,620

By adding LX4 model, fixed cost of $ 20,000 shall be levied.

The additional contribution would increase by 374,620-355,000 = 19,620 which is $ 380 less than original contribution.

Hence, model LX4 shall not be added.

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