Relevant costs, opportunity costs. Gavin Martin, the general manager of Oregano
ID: 2448816 • Letter: R
Question
Relevant costs, opportunity costs. Gavin Martin, the general manager of Oregano Software, must decide when to release the new version of Oregano’s spreadsheet package, Easyspread 2.0. Development of Easyspread 2.0 is complete; however, the diskettes, compact discs, and user manuals have not yet been produced. The product can be shipped starting July 1, 2014.
The major problem is that Oregano has overstocked the previous version of its spreadsheet package, Easyspread 1.0. Martin knows that once Easyspread 2.0 is introduced, Oregano will not be able to sell any more units of Easyspread 1.0. Rather than just throwing away the inventory of Easyspread 1.0, Martin is wondering if it might be better to continue to sell Easyspread 1.0 for the next three months and introduce Easyspread 2.0 on October 1, 2014, when the inventory of Easyspread 1.0 will be sold out. The following information is available:
Easyspread 1.0 Easyspread 2.0
Selling price $165 $215
Variable cost per unit of diskettes, CD's, user manuals 24 38
Development cost per unit 60 95
Marketing and administrative cost per unit 31 41
Total cost per unit 115 174
Operating income per unit $50 $41
Development cost per unit for each product equals the total costs of developing the software product divided by the anticipated unit sales over the life of the product. Marketing and administrative costs are fixed costs in 2014, incurred to support all marketing and administrative activities of Oregano Software. Marketing and administrative costs are allocated to products on the basis of the budgeted revenues of each product. The preceding unit costs assume Easyspread 2.0 will be introduced on October 1, 2014.
Required
1. On the basis of financial considerations alone, should Martin introduce Easyspread 2.0 on July 1, 2014, or wait until October 1, 2014? Show your calculations, clearly identifying relevant and irrelevant revenues and costs.
2. What other factors might Gavin Martin consider in making a decision?
Explanation / Answer
1. On the basis of financial considerations alone, should Martin introduce Easyspread 2.0 on July 1, 2014, or wait until October 1, 2014? Show your calculations, clearly identifying relevant and irrelevant revenues and costs.
The Development cost and marketing cost are sunk costs. Hence these cost are not relevant cost for comparison.
The relevant cost comparison is as under:
Easyspread 1.0 Easyspread 2.0
Selling price $165 $215
Less: Variable cost per unit of diskettes, CD's, user manuals 24 38
Contribution Margin per unit $141 $177
Since the contribution Margin per unit is more for Easyspread 2.0, hence the introduction of Easyspread 2.0 should not be postponed.
2. What other factors might Gavin Martin consider in making a decision?
The other factors to be considered are:
- The excepted sales in these three months of the new product and the sales of old product.
- The possibility of other competitor to introduce such product at cheaper price.