Question

Cabin Creek Company is considering adding of a new line of kitchen cabinets. The company’s accountant provided the following estimated data for these cabinets: Annual sales $ 800 units

Selling price per unit $ 3,690
Variable manufacturing costs per unit $ 1,690
Variable selling costs per unit $ 540
Incremental fixed costs per year:
Manufacturing $ 494,400
Selling $ 74,000
Allocated common costs per year:
Manufacturing $ 99,000
Selling and administrative $ 131,000
If the kitchen cabinets are added as a new product line, the company expects that the contribution margin earned from selling its other products will decrease by $238,000 per year.
Required:
What is the annual financial advantage (disadvantage) of adding the new line of kitchen cabinets?
What is the lowest selling price per unit that could be charged for the cabinets and still make it economically desirable for the company to add the new product line?

Answer 1

The annual financial advantage of adding the new line of kitchen cabinets is $361,600. To determine the lowest selling price per unit that could be charged for the cabinets and still make it economically desirable for the company, we must ensure the total contribution margin covers the increased costs and the loss of contribution from other products.

Step-by-step explanation:

Annual Financial Advantage of Adding New Kitchen Cabinets

To determine the annual financial advantage or disadvantage of adding the new line of kitchen cabinets, we first need to calculate the total contribution margin and then subtract any incremental and allocated costs associated with the new product line, as well as the lost contribution margin from other products. The contribution margin per unit is the selling price minus the variable costs (both manufacturing and selling).

Contribution margin per unit = Selling price per unit - Variable manufacturing costs per unit - Variable selling costs per unit

Contribution margin per unit = $3,690 - $1,690 - $540 = $1,460

Total annual contribution margin = Contribution margin per unit × Annual sales

Total annual contribution margin = $1,460 × 800 = $1,168,000

Next, we subtract the incremental fixed costs and the decreased contribution margin from other products:

Total annual incremental fixed costs = Manufacturing + Selling

Total annual incremental fixed costs = $494,400 + $74,000 = $568,400

Decreased contribution margin from other products = $238,000

Annual financial advantage (net contribution margin) = Total annual contribution margin - Total annual incremental fixed costs - Decreased contribution margin from other products

Annual financial advantage (net contribution margin) = $1,168,000 - $568,400 - $238,000 = $361,600

Since the net contribution margin is positive, the annual financial advantage of adding the new line is $361,600.

Lowest Selling Price to Make the Line Economically Desirable

To find the lowest selling price per unit that could be charged for the cabinets and still make it economically desirable for the company to add the new product line, we need to ensure that the total contribution margin covers the total annual incremental costs plus the loss of contribution margin from other products.

Let X be the lowest selling price per unit. Then:

X - $1,690 (variable manufacturing cost) - $540 (variable selling cost) = Contribution margin per unit

For the new product line to be desirable, the total annual contribution margin must be equal to or greater than the sum of the total annual incremental fixed costs and the loss from other products: (X - $2,230) × 800 ≥ $568,400 + $238,000

Solving for X gives us the lowest selling price per unit.

Answer 2

The annual financial advantage of adding the new line of kitchen cabinets would be $361,600. The lowest selling price per unit that could be charged to make the addition of the new product line economically desirable would be $3,238.

Step-by-step explanation:

To determine the annual financial advantage or disadvantage of adding the new line of kitchen cabinets, we need to calculate the total contribution margin and then subtract the additional incremental fixed costs and decrease in contribution margin from existing products. The contribution margin per unit is calculated as the selling price per unit minus the variable costs (both manufacturing and selling).

Contribution margin per unit = $3,690 (selling price per unit) - $1,690 (variable manufacturing costs) - $540 (variable selling costs) = $1,460.

Annual contribution margin = $1,460 (contribution margin per unit) × 800 (annual sales) = $1,168,000.

Now, we subtract the incremental fixed costs and the decrease in contribution margin from existing products:

Annual advantage/disadvantage = $1,168,000 (annual contribution margin) - $494,400 (incremental manufacturing fixed costs) - $74,000 (incremental selling fixed costs) - $238,000 (decrease in contribution margin from existing products) = $361,600 (annual advantage).

Therefore, the annual financial advantage of adding the new line of kitchen cabinets would be $361,600.

To calculate the lowest selling price per unit, we need to ensure that the contribution margin covers the incremental fixed costs and the decrease in the contribution margin from other products. With the existing variable costs, the total variable costs per unit are $1,690 + $540 = $2,230. The total annual fixed costs that need to be covered are $494,400 + $74,000 + $238,000 = $806,400. Spread over 800 units, this is $1,008 per unit. Therefore, the lowest selling price per unit is the sum of variable costs per unit and the per unit fixed costs that need to be covered, which is $2,230 + $1,008 = $3,238.