Question

Assume a company expects to sell 2 million packages of​ Pop-Tarts Gone​ Nutty! in the first year after introduction but expects that 70 percent of those sales will come from buyers who would normally purchase existing​ Pop-Tart flavors​ (that is, cannibalized​ sales). The price for a package of​ Pop-Tarts Gone​ Nutty! is ​$1.30 and its variable cost is ​$0.60​, when the price for a package of original​ Pop-Tart is ​$1.10 with variable cost of ​$0.35. Assuming the sales of regular​ Pop-Tarts are normally 300 million packages per year and that the company will incur an increase in fixed costs of ​$700 comma 000 during the first year to launch Gone​ Nutty! will the new product be profitable for the​ company? Determine the unit contributions and the loss for every package cannibalized from the original product.

Answer 1

Answer: launching the new product will be profitable.

Explanation:

Profitability of the new product calculation

Sales of the new product (pop tarts gone nutty) = 2000 000

Selling Price = $1.10

Variable costs = $ 0.35

Fixed costs        = $ 700 000

First thing to do we need to compare number of expected units to sold (sales) against the number of units required to be sold to break even. This step is done to when check whether expected sales will be enough to at least reach the point where the business makes no profit or loss from the new product sales.

Break-even point = fixed costs / (selling price – variable costs)

                               = 700 000/ (1.30 – 0.60)

Break-even point = 1000 000 units

Expected sales are 2000 000 and break-even point sales unit are 1000 000. Expected sales are more than the sales required to break even.

We are now calculating if it is profitable for the firm to launch the new product Pop-Tart Gone nutty. We calculate profits for the firm if they launch the product and compare with profits without the products. With the launch of the new product 70% of buyers are buyers who normally purchase the existing Pop-tart flavors, therefore 1400 000 buyers (2000 000×70%) are cannibalized.  

Sales unit for existing Pop Tart flavors = 300 000 000

 Sales units of existing products after the launch of the new products =                                                                                 300 000 -1400 000 = 298600 000

Profits margins from existing products (if new product is launched) = 298600000× (1.10-0.35)  = 223950 000

Existing product profit margin = 2000000× (1.30-0.60) = 1400 000  

Total profit with new product = 223950000 + 1400 000 = 225350 000

Profits without new product = 300 000 000 × (1.10-0.35) = 225000 000.

Profits when the new product is launched are higher.                                          The launching the new product will be profitable.

Unit contributions and loss

New product unit contribution = 1.30 – 0.60 = 0.70

Existing products unit contribution = 1.10 – 0.35 = 0.75

Loss from existing products = 0.75 × 1400000 = 1050000.

The existing pop tart flavors will suffer a loss of $1050000 when some of the buyers go for the new product