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		25,000	units		25,000	units
Estimated sales price	$	27.00		$	37.00
Estimated manufacturing cost per unit
Direct materials	$	17.50		$	19.50
Direct labor		4.50			7.00
Variable manufacturing overhead		3.50			5.50
Fixed manufacturing overhead		5.00			5.00
Unit manufacturing cost	$	30.50		$	37.00
Additional development cost				$	12,000

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?

	Yes
	No

3-a. Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 23,000 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?

	No

Answer 1

1) Statement showing increase or decrease in Profit (units 25,000) (Amts in $)

	Rose Umbrella		Decorated Umbrella
Particulars	Per unit	Amount	Per unit	Amount
Sales (A)	27.00	675,000	37.00	925,000
Less: Manufacturing Cost
Direct Materials	17.50	437,500	19.50	487,500
Direct Labor	4.50	112,500	7.00	175,000
Variable Manufacturing Overhead	3.50	87,500	5.50	137,500
Fixed Manufacturing Cost	5.00	125,000	5.00	125,000
Additional Development Cost	0	0	0.48	12,000
Total cost (B)	30.50	762,500	37.48	937,000
Net Profit/(Loss) (A - B)	(3.50)	(87,500)	(0.48)	(12,000)

As the net loss of $87,500 has been decreased to $12,000, it means there is an increase in profit of $75,500 ($87,500 - $12,000). Therefore, the profit will increased by $75,500 if Mohave sells the Rosa Umbrella with the additional decorations.

2) Yes, Mohave should add decorations to the Rosa umbrella because there is an increase in profit by $75,500.

3-a) Profit after adding decorations = Sales - Variable Manuf. Cost - Fixed Cost - Additional Development Cost

= (23,000 units*$37) - (23,000 units*$32) - (25,000 units*$5) - $12,000

= $851,000 - $736,000 - $125,000 - $12,000 = ($22,000)

The loss before addition of decorations was $87,500 and loss after addition of decorations is $22,000. Hence there is an increase in profit of $65,500 ($87,500 - $22,000).

3-b) Yes, Mohave should add decorations to the Rosa umbrella becuase there is an increase in profit of $65,500.