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.

E7-8 Analyzing Sell-or-Process-Further Decision [LO 7-2, 7-6]

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			37,000	units			37,000	units
Estimated sales price		$	31.00			$	48.00
Estimated cost per unit
Direct materials		$	5.75			$	8.25
Direct labor			8.00				12.00
Variable manufacturing overhead			8.00				11.25
Fixed manufacturing overhead			8.50				8.50
Unit manufacturing cost		$	30.25			$	40.00
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.

	CD Only CD with Instructions Materials Incremental Sales Revenue Variable Costs Contribution Margin Additional Development Costs Differential Profit (Loss)

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

	Sell the CDs without Instructional Materials
	Add the Instructional Materials

  
3-a. Suppose that the higher price of the CDs with instructional materials is expected to reduce demand to 19,000 units. Complete the table given below based on Requirement 1 and 2 data.

	CD Only CD with Instructions Materials Incremental Sales Revenue Variable Costs Contribution Margin Additional Development Costs Differential Profit (Loss)

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

	Sell the CDs without Instructional Materials
	Add the Instructional Materials

Answer 1

Ans. 1 Computer increase or decrease for the result of selling CD with Instructional materials ( all value in $)

                                                        CD                             CD with Instructional materials     Incremental

Unit                                                37000                           37000                                          -

Sales                                             1147000                        1776000                                    629000

Variable cost(21.75X37000)             (804750) (1165500)    (360750)

   (31.50X37000)                -                                 

Contribution margin                         342250                           610500                                      268250

Additional Development cost - (105000)    (105000)   

Profit /Loss                                    342250                           505500                                       163250

Increamental Profit is $163250

2. Company should Add the Instructional materials because it will increase company profitability by $163250

3. If CD with Instructional Sales are reduced to 19000 unit, compute the incremental profit or loss

                                                      CD                             CD with Instructional materials     Incremental

Unit                                                37000                           1900

SP per unit                                      31                                 48

Sales                                             1147000                        912000                                  

Variable cost(21.75X37000)             (804750) (598500)   

   (31.50X19000)                -                                 

Contribution margin                         342250                           313500                                      (28750)

Additional Development cost - (105000)    (105000)   

Profit /Loss                                    342250                           207500                                      (133750)

In this situation company Incremental Loss is $133750

3b. In this case company sell only CD without Instrumental materials.