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			38,000	units			38,000	units
Estimated sales price		$	33.00			$	49.00
Estimated cost per unit
Direct materials		$	6.25			$	8.75
Direct labor			8.50				12.50
Variable manufacturing overhead			8.50				11.75
Fixed manufacturing overhead			9.00				9.00
Unit manufacturing cost		$	32.25			$	42.00
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 20,000 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

Answer-1)-The profit will be increase by $132500, if instructional materials were added to the CDs.

Explanation-

Morning Sky Inc. (MSI)

Particulars	CD Only	CD with instructions Materials	Incremental
	(a)	(b)	(c=a-b)
Sales revenue	38000 units*$33 per unit=1254000	38000 units*$49 per unit=1862000	608000
Less:- Variable costs	38000 units*$23.25 per unit=883500	38000 units*$33 per unit=1254000	370500
Contribution margin	370500	608000	237500
Less-Additional Developments costs	Nil	105000	105000
Differential profit (loss)	370500	503000	132500

2)- MSI should add the instructional materials due to incremental profit of $132500.

3-a)-

Morning Sky Inc. (MSI)
Particulars	CD Only	CD with instructions Materials	Incremental
	(a)	(b)	(c=a-b)
Sales revenue	38000 units*$33 per unit=1254000	20000 units*$49 per unit=980000	-274000
Less:- Variable costs	38000 units*$23.25 per unit=883500	20000 units*$33 per unit=660000	223500
Contribution margin	370500	320000	-50500
Less-Additional Developments costs	Nil	105000	105000
Differential profit (loss)	370500	215000	-155500

3-b)- 3-b)- MSI should sell the CDs without them due to incremental loss of $155500.