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		15,000	units		15,000	units
Estimated sales price	$	13.00		$	24.00
Estimated manufacturing cost per unit
Direct materials	$	7.50		$	9.50
Direct labor		2.50			5.00
Variable manufacturing overhead		1.50			3.50
Fixed manufacturing overhead		3.00			3.00
Unit manufacturing cost	$	14.50		$	21.00
Additional development cost				$	15,000

Required:
1. 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)

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 13,000 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)

3-b. Should Mohave add decorations to the Rosa umbrella?

	No
	Yes

Answer 1

1)	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue (15,000 units * $13 per unit); (15,000 units * $24 per unit)	$195,000	$360,000	$165,000
Less: Variable Costs ($7.5 + $2.5 + $1.5 = $11.5 * 15,000 units); ($9.5 + $5 + $3.5 = $18 * 15,000 units)	($172,500)	($270,000)	($97,500)
Contribution Margin	$22,500	$90,000	$67,500
Less: Additional Development Costs	$0	($15,000)	($15,000)
Differential Profit (Loss)	$22,500	$75,000	$52,500
2)
Yes, Mohave can add decorations to the Rosa Umbrella because the incremental revenue is $52,500 which is positive.
3-a)	Rosa Umbrella	Decorated Umbrella	Incremental
Sales Revenue (13,000 units * $13 per unit); (13,000 units * $24 per unit)	$169,000	$312,000	$143,000
Less: Variable Costs ($7.5 + $2.5 + $1.5 = $11.5 * 13,000 units); ($9.5 + $5 + $3.5 = $18 * 13,000 units)	($149,500)	($234,000)	($84,500)
Contribution Margin	$19,500	$78,000	$58,500
Less: Additional Development Costs	$0	($15,000)	($15,000)
Differential Profit (Loss)	$19,500	$63,000	$43,500
3-b)
Yes, Mohave can add decorations to the Rosa Umbrella because the incremental revenue is $43,500 which is positive.