Question

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			30,000	units			30,000	units
Estimated sales price		$	26.00			$	41.00
Estimated cost per unit
Direct materials		$	4.25			$	4.75
Direct labor			5.50				8.50
Variable manufacturing overhead			5.50				8.75
Fixed manufacturing overhead			5.00				5.00
Unit manufacturing cost		$	20.25			$	27.00
Additional development cost						$	105,000

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.

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

3-a. Suppose that the higher price of the CDs with instructional materials is expected to reduce demand to 21,000 units. Complete the table given below based on Requirement 1 and 2 data.

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

Answer 1

1. Computation of the increase or decrease in profit that would result if instructional materials were added to the CDs:

Particulars	Basis	CD Only	CD with instruction material
Units Sold	A	30,000	30,000
SP Per unit	B	$26	$41
Sales	C=A*B	$780,000	$1,230,000
Expenses:
Direct Material	D=A*4.25	$127,500
	D=A*4.75		$142,500
Direct Labor	E=A*5.5	$165,000
	E=A*8.5		$255,000
Variable manufacturing overhead	F=A*5.5	$165,000
	F=A*8.75		$262,500
Fixed manufacturing overhead	G	$150,000	$150,000
Additional Development cost*	H		$105,000
Total Expenses	I=D+E+F+G+H	$607,500	$915,000
Profit	J=C-I	$172,500	$315,000

Therefore, increase in profit = $315,000-$172,500 = $142,500.

* As it has not been given whether additional development cost is a one time expense or will be incurred throughout the life, it has been assumed it will be incurred every year.

2. As there is increase in profit by $142,500 every year it will be beneficial for the company to sell them by adding the instructional materials.

3. Computation of profit after change in demand

Particulars	Basis	CD with instruction material
Units Sold	A	21,000
SP Per unit	B	$41
Sales	C=A*B	$861,000
Expenses:
Direct Material	D=A*4.25
	D=A*4.75	$99,750
Direct Labor	E=A*5.5
	E=A*8.5	$178,500
Variable manufacturing overhead	F=A*5.5
	F=A*8.75	$183,750
Fixed manufacturing overhead	G	$150,000
Additional Development cost*	H	$105,000
Total Expenses	I=D+E+F+G+H	$717,000
Profit	J=C-I	$144,000

Therefore, decrease in profit = $172,500-$144,000 = $28,500.

* As it has not been given whether additional development cost is a one time expense or will be incurred throughout the life, it has been assumed it will be incurred every year.

3-b As there is a decrease in profit by $28,500 every year, therefore the company should not add the additional instructions kit to their product.

Meanwhile, if the additional development cost is a one time expense then the company will be gaining profit of $144,000+$105,000 = $249,000 which will result in increase in profit by $249,000-$172,500 = $76,500 from the second year onwards. In that case, it will be beneficial for the company to sell them by adding the instructional materials.

But if additional development cost is a fixed time expense then company should not add the additional instructions kit to their product.