Question

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

               Model          Selling Price            Variable Cost      Demand/Year

                                  Per Computer           Per Computer               (Units)

                MS-1              $1,000                          $800                        2,000

                MS-2              $2,000                        $1,200                        1,000

                MS-3              $2,400                        $1,400                           700

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

This model, the LX-4 would be sold for $3,000.

The variable cost of this unit is the last 3 digits of your Banner ID $215

The demand for the new Model LX-4 is estimated to be 500 units per year.

40% of the new model’s unit sales are expected to come from the existing three models already being manufactured by Morningstar.

10% of the cannibalized amount from Model MS-1,

30% of the cannibalized amount from Model MS-2,

60% of the cannibalized amount from Model MS-3.

Morningstar Computer will incur a fixed cost of $300,000 to add the new model LX-4 to its product line.

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

Questions:

1) What is the unit cannibalization from each of the 3 original products after LX-4 model is launced

2) What is unit contribution for LX-4

3) Based on your data above should Morningstar add the new Model LX-4 and why?

Answer 1

SOLUTION:

Unit Contribution margin for LX 4 =$3,000 - $215 =$2,785 per unit
Contribution margin of existing model:
MS 1 =$1,000 - $ 800 =$200
MS 2 =$2,000 - $1,200 =$800
MS 3 =$2,400 - $1,400 =$1,000
Additional Contribution margin from sale of LX 4 =500*$2,785 =$1,392,500
Total unit sale loss of existing model =500*40% =200 units
Lost Contribution margin of MS 1 =200*10%*$200 =	$4,000
Lost Contribution margin of MS 2 =200*30%*$800 =	$48,000
Lost Contribution margin of MS 3 =200*60%*$1,000 =	$120,000
Total Contribution margin lost =	$172,000
Additional Fixed cost to add new model =$300,000©
Net Cash flowby end of 1st year of project =$1,392,500 - $172,000 - $300,000 =$920,500
Since the Net cash flow is positive hence the LX 4 should be introduced