Question

Roland Company operates a small factory in which it manufactures two products: A and B. Production and sales result for last year were as follow:
A B
Units sold 8,000 16,000
Selling price per unit 65 52
Variable costs per unit 35 30
Fixed costs per unit 15 15

For purposes of simplicity, the firm allocates total fixed costs over the total number of units of A and B produced and sold.

The research department has developed a new product (C) as a replacement for product B. Market studies show that Roland Company could sell 11,000 units of C next year at a price of $80, the variable costs per unit of C are $39. The introduction of product C will lead to a 10% increase in demand for product A and discontinuation of product B. If the company does not introduce the new product, it expects next year's result to be the same as last year's.

Answer 1

Answer:

Check the following explanation

Explanation:

Roland Company

Basic calculation –

Contribution margin and net income of products A and B

                                               A                B

Sales (units)                           8,000          16,000

Selling price                             $65             $52

Variable cost                           $35             $30

Unit Contribution margin        $30             $22

Contribution margin                $240,000    $352,000

Fixed Cost                               $120,000    $240,000

Net income                              $120,000    $112,000

Analysis of profitability of Product C is introduced –

10% Increase in sales of Product A

Discontinuation of Product B

Incremental revenue – 10% increase in sales of Product A

Increased units =10% x 8,000 = 800 units

Additional contribution margin = $30 x 800 =$24,000

Incremental cost – contribution loss from discontinuation of product B

16,000 x 22 =$352,000

Profitability of C

Sales price (11,000 units)        $80

Variable cost                           $39

Unit contribution margin                  $41

Contribution margin                $451,000    (11,000 x $41)

Add: incremental revenue        $24,000      (contribution margin from additional units of Product A)

Total income                           $475,000

Less: Incremental cost             $352,000    (loss of contribution from discontinuation of Product B)

Net increase in income             $123,000

Note: The fixed costs are irrelevant for the decision to introduce Product C, as those costs are sunk costs and the firm allocates the same to products on a predetermined basis and not directly traceable.

Yes, Roland Company should introduce Product C next year.

Explanation: As the decision results in incremental revenue of $123,000 the introduction of Product C is profitable.