Question

Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability.

MSI’s educational products are currently sold without any supplemental materials. The company is considering the inclusion of instructional materials such as an overhead slide presentation, potential test questions, and classroom bulletin board materials for teachers. A summary of the expected costs and revenues for MSI’s two options follows:

	CD Only				CD with Instructional Materials
Estimated demand			43,000	units			43,000	units
Estimated sales price		$	27.00			$	54.00
Estimated cost per unit
Direct materials		$	2.50			$	2.75
Direct labor			3.00				6.00
Variable manufacturing overhead			3.00				6.25
Fixed manufacturing overhead			3.00				3.00
Unit manufacturing cost		$	11.50			$	18.00
Additional development cost						$	125,000

  
Required:
1. Based on the given data, Compute the increase or decrease in profit that would result if instructional materials were added to the CDs.

	CD only	CD with Instructions Materials	Incremental
Sales Revenue
Variable Costs
Contribution Margin
Additional Development Costs
Differential Profit (Loss)

2. Should MSI add the instructional materials or sell the CDs without them?

	Sell the CDs without Instructional Materials
	Add the Instructional Materials

  
3-a. Suppose that the higher price of the CDs with instructional materials is expected to reduce demand to 20,000 units. Complete the table given below based on Requirement 1 and 2 data.

	CD only	CD with Instructions Materials	Incremental
Sales Revenue
Variable Costs
Contribution Margin
Additional Development Costs
Differential Profit (Loss)

  

3-b. Should MSI add the instructional materials or sell the CDs without them?

	Sell the CDs without Instructional Materials
	Add the Instructional Materials

Answer 1

Answer-1)-

Morning Sky Inc. (MSI)
Particulars	CD Only	CD with instructions Materials	Incremental
	(a)	(b)	(c=a-b)
Sales revenue	43000 units*$27 per unit=1161000	43000 units*$54 per unit=2322000	1161000
Less:- Variable costs	43000 units*$8.50 per unit=365500	43000 units*$15 per unit=645000	279500
Contribution margin	795500	1677000	881500
Additional Developments costs	Nil	125000	125000
Differential profit (loss)	795500	1552000	756500

2)-MSI should add the instructional materials due to incremental profit of $756500.

3-a)-

Morning Sky Inc. (MSI)
Particulars	CD Only	CD with instructions Materials	Incremental
	(a)	(b)	(c=a-b)
Sales revenue	43000 units*$27 per unit=1161000	20000 units*$54 per unit=1080000	-81000
Less:- Variable costs	43000 units*$8.50 per unit=365500	20000 units*$15 per unit=300000	65500
Contribution margin	795500	780000	-15500
Additional Developments costs	Nil	125000	125000
Differential profit (loss)	795500	655000	-140500

3)-b)- MSI should not add the instructional materials or sell the CDs without them due to incremental loss of $140500.