Question

Tharp Company operates a small factory in which it manufactures two products: C and D. Production and sales results for last year were as follows.

		C		D
Units sold		8,800		19,000
Selling price per unit		$93		$75
Variable cost per unit		47		39
Fixed cost per unit		20		20

For purposes of simplicity, the firm averages total fixed costs over the total number of units of C and D produced and sold.

   The research department has developed a new product (E) as a replacement for product D. Market studies show that Tharp Company could sell 11,000 units of E next year at a price of $113; the variable cost per unit of E is $40. The introduction of product E will lead to a 10% increase in demand for product C and discontinuation of product D. If the company does not introduce the new product, it expects next year’s results to be the same as last year’s.

Compute company profit with products C & D and with products C & E.

Net profit with products C & D		$
Net profit with products C & E		$

Should Tharp Company introduce product E next year?

YesNo

Answer 1

1. Net profit with products C & D = $ 532,800

Calculation

	Product C	Product D
per unit	8,800 units	per unit	19,000 units
Sales	$ 93	$ 818,400	$ 75	$ 1,425,000
Less: Variable cost	($ 47)	($ 413,600)	$ 39	($ 741,000)
Contribution margin	$ 46	$ 404,800	$ 36	$ 684,000
Less: Fixed cost	($ 20)	($ 176,000)	$ 20	($ 380,000)
Net profit	$ 26	$ 228,800	$ 16	$ 304,000

Total net profit from products C & D = $228,800 + $304,000 = $532,800

2. Net profit with products C & E = $ 692,280

And the Tharp company should introduce Product E next year. Because the net profit has increased from $532,800 to 692,280. So, the introduction of product E will increase the net profit by $159,480.  

($159,480 = $692,280 - $532,800)

Calculation

	Product C	Product E
Per unit	9,680 units	Per unit	11,000 units
Sales	$ 93	$ 900,240	$ 113	$ 1,243,000
Less: Variable cost	($ 47)	($ 454,960)	($ 40)	($ 440,000)
Contribution margin	$ 46	$ 445,280	$ 73	$ 803,000
Less: Fixed cost	($ 18.18)	($ 176,000)	($ 34.54)	($ 380,000)
Net profit	$ 27.82	$ 269,280	$ 38.45	$ 423,000

Total net profit from products C & E = $269,280 + $423,000 = $692,280

NOTES:

a. The demand for product C will increase by 10% due to introduction of product E

Demand (sales) for product C = 8,800 + (10% of 8,800) = 8,800 + 880 = 9,680 units

b. The fixed costs of Product C & D have been averaged over the total number of units produced and sold.

1. Total fixed cost of product c = $20 * 8,800 = $176,000

So, for product C, whatever the number of units produced and sold, total fixed cost will remain $176,000

Fixed cost per unit in case of 9,680 units = $176,000 / 9,680 = $18.18

2. Total fixed cost for product D = $20 * 19,000 = $380,000

The introduction of product E is a replacement for Product D. So, let's assume that the total fixed cost for product C & product E would be same.

Fixed cost per unit for product E(11,000 units) = $380,000 / 11,000 = $34.54