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:

	Rosa Umbrella			Decorated Umbrella
Estimated demand		13,000	units		13,000	units
Estimated sales price	$	11.00		$	22.00
Estimated manufacturing cost per unit
Direct materials	$	5.50		$	7.50
Direct labor		1.50			4.00
Variable manufacturing overhead		0.50			2.50
Fixed manufacturing overhead		2.00			2.00
Unit manufacturing cost	$	9.50		$	16.00
Additional development cost				$	13,000

Required:
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 11,000 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?

Answer 1

Solution 1:
Computation of Increase or decrease in profit - If Mohave sells the Rose Umberella with additional decorations
Particulars	Rose Umberella	Decorated Umberella	Incremental
Sales Revenue	$143,000.00	$286,000.00	$143,000.00
Variable Cost (Rose - $7.50, Decorated - $14)	$97,500.00	$182,000.00	$84,500.00
Contribution margin	$45,500.00	$104,000.00	$58,500.00
Additional development cost	$0.00	$13,000.00	$13,000.00
Differential Profit (Loss)	$45,500.00	$91,000.00	$45,500.00
Solution 2:
Yes, Mohave should add decorations to Rose Umbrella
Solution 3a:
Computation of Increase or decrease in profit - If Mohave sells the Rose Umberella with additional decorations - Falls in sale of decorated umberella to 11000 units
Particulars	Rose Umberella	Decorated Umberella	Incremental
Sales Revenue	$143,000.00	$242,000.00	$99,000.00
Variable Cost (Rose - $7.50, Decorated - $14)	$97,500.00	$154,000.00	$56,500.00
Contribution margin	$45,500.00	$88,000.00	$42,500.00
Additional development cost	$0.00	$13,000.00	$13,000.00
Differential Profit (Loss)	$45,500.00	$75,000.00	$29,500.00
Solution 3b:
Yes, Mohave should add decorations to Rose Umbrella