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		27,000	units		27,000	units
Estimated sales price	$	29.00		$	39.00
Estimated manufacturing cost per unit
Direct materials	$	19.50		$	21.50
Direct labor		4.50			7.00
Variable manufacturing overhead		3.50			5.50
Fixed manufacturing overhead		6.00			6.00
Unit manufacturing cost	$	33.50		$	40.00
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?
3-a. Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 25,000 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?

1.

	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue
Variable Costs
Contribution Margin
Additional Development Costs
Differential Profit (Loss)

3.

Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 25,000 units. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.

	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue
Variable Costs
Contribution Margin
Additional Development Costs
Differential Profit (Loss)

Answer 1

		Case 1	Case 2
Particulars	Rosa umbrella	Decorated umbrella	Decorated umbrella
Estimated Demand	27000	27000	25000
Estimated Sells Price	29	39	39
Estimated total sales	783000	1053000	975000
Less: variable cost
Variable cost per unit	27.5	34	34
Total Variable cost	742500	918000	850000
Contribution Margin	40500	135000	125000
Less: Fixed Cost	162000	162000	162000
Less: Additional development cost	0	12000	12000
Loss	-121500	-39000	-49000
Answer 1: Selling Decorated umbrella would reduce the amount of loss
Answer 2: Yes, as adding it would reduce the loss
Answer 3 : Differential loss would increase by 10000.