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Question: A company manufactures a single product in its factory utilizing 60% of its capacity. The selling price and cost details are given below:
12.5% of factory overheads and 20% of selling and distribution overheads are variable with production and sales.
Administrative overheads are wholly fixed.
Since the existing product could not achieve budgeted level for two consecutive years, the Company decides to introduce a new product with marginal investment but largely using the existing plant and machinery.
The cost estimates of the new product are as follows:
It is expected that 2,000 units of the new product can be sold at a price of Rs. 60 per unit. The fixed factory overheads are expected to increase by 10%, while fixed selling and distribution expenses will go up by Rs. 12,500 annually. Administrative overheads remain unchanged. However, there will be an increase of working capital to the extent of Rs. 75,000, which would take the total cost of the project to Rs. 8.75 lakh.
The company considers that 20% pre-tax and interest return on investment is the minimum acceptable to justify any new investment.
You are required to
(a) Decide whether the new product be introduced.
(b) Make any further observations/recommendations about profitability of the Company on the basis of the above data, after making assumption that the present investment is Rs. 8 lakh.
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