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		27,000	units		27,000	units
Estimated sales price	$	29.00		$	39.00
Estimated manufacturing cost per unit
Direct materials	$	19.50		$	21.50
Direct labor		4.50			7.00
Variable manufacturing overhead		3.50			5.50
Fixed manufacturing overhead		6.00			6.00
Unit manufacturing cost	$	33.50		$	40.00
Additional development cost				$	12,000

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 25,000 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?

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Answer 1

1.

	Rosa Umbrella	Decorated Umbrella
Sales revenue	$783,000 (27,000*$29)	$1,053,000 (27,000*$39)
Variable costs	742,500 (27,000*$27.5)	918,000 (27,000*$34)
Contribution margin	40,500	135,000
Additional development cost		12,000
Differential profit (loss)	$40,500	$123,000

2.

Yes.

3-a.

	Rosa Umbrella	Decorated Umbrella
Sales revenue	$783,000 (27,000*$29)	$975,000 (25,000*$39)
Variable costs	742,500 (27,000*$27.5)	850,000 (25,000*$34)
Contribution margin	40,500	125,000
Additional development cost	0	12,000
Differential profit (loss)	$40,500	$113,000

3-b.

Yes.