The Rosa model of Mohave Corp. is currently manufactured as a very plain umbrell

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:

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 18,000 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?

Rosa Umbrella Decorated Umbrella Estimated demand 20,000 units 20,000 units Estimated sales price $ 22.00 $ 32.00 Estimated manufacturing cost per unit Direct materials $ 12.50 $ 14.50 Direct labor 3.50 6.00 Variable manufacturing overhead 2.50 4.50 Fixed manufacturing overhead 4.00 4.00 Unit manufacturing cost $ 22.50 $ 29.00 Additional development cost $ 10,000

Explanation / Answer

(all figures in $) 1 Rose umbrella decorated umbrella Incremental Sales revenue (estimated demand * estimated sales price)              4,40,000          6,40,000           2,00,000 a Variable costs per unit (direct materials p.u + direct labour p.u + variable manufacturing overheads p.u)                          19                      25                          7 Total Variable cost (estimated demand * variable cost per unit)              3,70,000          5,00,000           1,30,000 b Contribution margin (a-b)                  70,000          1,40,000               70,000 c= a-b Additional development cost                           -                10,000               10,000 d Differential profit/(loss)               60,000 c-d (increase in profit) 2 Based on the above working with an estimated demand of 20000 umbrellas, Mohave should sell the Rosa umbrellas with the decoration as this will give Mohave an additional profit of $60000 3a If higher price of the decorated umbrella will reduce the estimated demand of the new product to 18000units Rose umbrella decorated umbrella Incremental Sales revenue (estimated demand * estimated sales price)              4,40,000          5,76,000           1,36,000 a Variable costs per unit (direct materials p.u + direct labour p.u + variable manufacturing overheads p.u)                          19                      25                          7 Total Variable cost (estimated demand * variable cost per unit)              3,70,000          4,50,000               80,000 b Contribution margin (a-b)                  70,000          1,26,000               56,000 c= a-b Additional development cost                           -                10,000               10,000 d Differential profit/(loss)               46,000 c-d (increase in profit) 3b Based on the above working with an estimated demand of 18000 umbrellas, Mohave should sell the Rosa umbrellas with the decoration as this will give Mohave an additional profit of $46000

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