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 10,000 units 10,000 units
Estimated sales price $ 8.00 $ 19.00
Estimated manufacturing cost per unit
Direct materials $ 2.50 $ 5.50
Direct labor 1.50 4.00
Variable manufacturing overhead 0.50 2.50
Fixed manufacturing overhead 2.00 2.00
Unit manufacturing cost $ 6.50 $ 14.00
Additional development cost $ 10,000
Required:
1. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
Rosa umbrella Decorated Umbrella Incremenral
sales revenue
variable cost
contribution margin
additional development cost
differential profit
2. Should Mohave add decorations to the Rosa umbrella?
Yes
No
3-a. Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 8,000 units. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
Rosa Umbrella Decorated Umbrella Incremental
sales revenue
variable cost
contribution marginal
additional development cost
differential profit
3-b. Should Mohave add decorations to the Rosa umbrella?
Yes
No

Answer 1

Solution :

1. Incremental analysis when the demand for the decorated umbrella is 10,000 units.

$\text{Particulars}$                 $\text{Rosa umbrella}$     $\text{Decorated umbrella}$          $\text{Incremental}$

$\text{Sales revenue}$             $80000                 $190000                       $110000

$\text{Less: Variable cost}$     $ 45000                $120000                       $75000

Contribution                $35000                 $70000                         $35000

$\text{Less: Additional}$            ---                          $10000                         $10000

development cost.

$\text{Differential profit}$         $35000                 $60000                        $25000

The company earns an additional profit of $\ 25,000$ if it decorates and sells the Rosa umbrella.

2. The company, Mohave should add the decorations to the Rosa umbrella as this would increase the net revenues of the company by an amount of $25,000.

3.a. The demand for he decorated umbrella will fall to 8,000 units due to the higher price. If the company does not make any changes to the Rosa umbrella, it could sell 10,000 units.

The incremental profit or loss is :

Incremental analysis when the demand for the Rosa umbrella is 10,000 units and for the decorated umbrella is 8,000 units is given below:

$\text{Particulars}$                 $\text{Rosa umbrella}$     $\text{Decorated umbrella}$      $\text{Incremental}$

$\text{Sales revenue}$            $80,000             $152,000                       $72,000

$\text{Less: Variable cost}$   $45,000              $96,000                       $51,000

Contribution               $35,000              $56,000                      $21,000

$\text{Less: Additional}$             ----                    $10,000                        $10,000

development cost.

$\text{Differential profit}$     $35,000                $46,000                        $11,000

The incremental profits are : $11,000.

3.b. The company should decorate and sell 8000 units of the decorated umbrellas as the increase in the net profit is $11,000.