LeeAnn and Pat have been discussing the introduction of an improved Gizmo to replace our current model. LeeAnn wants to keep the selling price the same to avoid losing any customers. Pat has projected the costs to produce the improved Gizmo (see below). The higher costs are due to better materials used in the manufacturing process of the improved Gizmo and the higher labor time per unit needed to produce the improved Gizmo.
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Current Gizmo
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Improved Gizmo
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Selling price
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$75.00
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$75.00
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Manufacturing costs:
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Direct materials
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21.00
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$25.00
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Direct Labor
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3.75
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5.00
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Fixed Manufacturing overhead
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10.63
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14.17
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Total manufacturing costs
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35.38
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44.17
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Profit per unit
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$39.62
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$30.83
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Total fixed manufacturing overhead
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$850,000
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Total fixed operating expenses
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$800,000
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I will be meeting to discuss this with LeeAnn and Pat. I need your assistance to prepare for this meeting. Please provide me with the answers to the following questions:
- What level of sales do we need in units and dollars to breakeven on the current Gizmo? The improved Gizmo?
- How much would we have to raise the selling price to maintain our current operating income? We sell 80,000 Gizmos and expect volume of the improved Gizmos would be the same.
- Because demand is relatively inelastic, does LeeAnn's recommendation to keep the price the same make sense? Which pricing strategy would you recommend and why?
Midwest Fan, Inc.
Internal Memorandum
To: You
From: LeeAnn Brown, Marketing Manager
Date: March 8, 2013
Re: New product offering
The marketing and production teams will be meeting to discuss the introduction of a new product to our product line next year. It's called the Thermogizmo. Our current Gizmo is a high volume mature product with an established customer base. Customers tend to process their repeat orders through our online ordering system resulting in a relatively low cost-to-serve. We have been considering improving the current model but a better strategy may be to introduce the Thermogizmo, a specialty product customized to each customer's specific need. Here is the most recent data related to our current Gizmo and the new Thermogizmo.
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Current Gizmo
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Thermogizmo
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Selling price
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$75.00
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$90.00
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Manufacturing costs:
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Direct materials
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21.00
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28.00
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Direct labor
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3.75
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7.50
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Fixed manufacturing overhead
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10.63
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21.25
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Total manufacturing costs
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35.38
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56.75
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Profit per unit
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$39.62
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$33.25
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Annual production/sales (units)
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50,000
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15,000
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Direct labor hours per unit
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.25
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.50
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Average direct labor hour rate
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$15.00
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$15.00
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Manufacturing overhead budget
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$850,000
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Fixed operating expenses
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$800,000
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Based on the above projected product mix for next year, Kelly put together the following operating income projection.
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Gizmo
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Thermogizmo
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Total
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Sales
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$3,750,000
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$1,350,000
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$5,100,000
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Variable costs
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1,237,500
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532,500
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1,770,000
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Contribution margin
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$2,512,500
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$817,500
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$3,330,000
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Fixed costs
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1,650,000
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Operating income
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$1,680,000
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We hope you can provide us with your input to our strategy meeting. Here are our questions:
- What level of sales do we need to breakeven assuming my product mix?
- We've discussed the possibility of reallocating some of our marketing dollars from the Gizmo to the Thermogizmo to better promote this higher margin product. With this plan, we project the product mix will change Gizmo sales of 30,000 units and Thermogizmo sales of 25,000 units. What impact would this have on our operating income and breakeven point in sales dollars?
- What do you recommend we do?