3A Kneller Knitwear Inc. is considering the addition of a new line of socks next
ID: 2508552 • Letter: 3
Question
3A Kneller Knitwear Inc. is considering the addition of a new line of socks next year. First year sales of Tuff-Stuff socks are projected at 3 million pair. The table below provides price and cost data. The sources of these sales are expected to be: 15% of sales to new customers, 45% to competitors, customers and 40% to previous buyers of Knel lers other brand "Socko." Sales of Socko totaled 2 million pair this year and are expected to remain at this level if Tuff-Stuff is not introduced. Dan Douglas, manager of the Sock Division, is concerned about the cannibalization of Socko sales by Tuff-Stfff. How would t introduction of Tuff-Stuff affect Kneller's net profit? Should Tuff-Stuff be introduced? Current Year Year 1 with New Line Socko Socko Tuff-Stuff $1.90$1.90 Factory Selling Price Variable Costs Fixed Costs $2.35 $1.15$1.60 $825,000.00 $645,000.00 $1,510,000.00 $1.15Explanation / Answer
The projected sales of Tuf-Stuff is 3 million pair.
Out of this 40% is to the buyers of 'Socko' brand. Since the contribution margin from the two brands is the same, this sale of 40% shall not be taken into account for considering the profitability of the new brand.
Projected Sales = 1.8 million pairs
Contribution margin per pair = $0.75 ($2.35 - $1.60)
Total contribution in one year = $1,350,000 ( 1,800,000 x $0.75)
Total fixed costs for the Tuff-Stuff = $1,510,000
Net operating Income = -$160,000.
The net profit for the company will be reduced by $160,000 if the new line is introduced.
As the new product is not contributing fully to the fixed costs, the new line shll not be introduced.