Question

Sun Microsystems, is a manufacturer of mid-size computers, which are primarily used by medium and small businesses. Sun Microsystems’s product line currently consists of three models of mid-size computers. The following data are available regarding the models:

Model	Selling Price per Unit	Variable Cost per Unit	Demand/Year (units)
Model LX1	$1,600	$1,000	2,000
Model LX2	$2,400	$1,300	1,000
Model LX3	$2,900	$1,400	500

Sun Microsystems is considering the addition of a fourth model to its line of mid-size computers.

This model, the SMX-4 would be sold for $3,500.  
The variable cost of this unit is $153
The demand for the new Model SMX4 is estimated to be 600 units per year.  
Sixty percent of the new model’s unit sales are expected to come from other models already being manufactured by Sun Microsystems
60% of the cannibalized amount from Model SMX-1,
   10% from Model SMX-2,
   30% from Model SMX-3.
Sun Microsystems will incur a fixed cost of $200,000 to add the new model SMX-4 to its product line.

The president of Sun Microsystems will only fund projects which show a positive cash flow by the end of the first year of the project.   

Answer the following questions:

1.What is unit contribution for SMX-4

2. Based on the above data should Sun Microsystems add the new Model SMX-4 to its line of mid-size computers?  

3. Why

Answer 1

Soluiton 1:

Unit contribution for SMX-4 = $3,500 - $153 = $3.347 per unit

Solution 2 and 3:

Contribution margin per unit of existing model:

LX1 = $1,600 - $1,000 = $600

LX2 = $2,400 - $1,300 = $1,100

LX3 = $2,900 - $1,400 = $1,500

Additional contribution margin from sale of SMX 4 = 600 * $3,347 = $2,008,200

Total unit sale loss of existing models = 600 * 60% = 360 units

Lost sale of SMX 1 = 360 * 60% = 216 units

Lost sale of SMX2 = 360 * 10% = 36 units

Lost sale fo SMX 3 = 360 * 30% = 108 units

Total contribution margin lost = (216*$600) + (36 * $1,100) + (108 * $1,500)

= $331,200

Additional fixed cost to add new model = $200,000

Net cash flow by end of first year of project = $2,008,200 - $331,200 - $200,000 = $1,477,000

As cash flow is positive, therefore Sun microsystem should add teh new model SMX-4 to its mid sized computers.