Question 3
Shoe Co, a shoe manufacturer, has developed a new product called the ‘Smart Shoe’ for children, which has a built-in tracking device.
The shoes are expected to have a life cycle of two years, at which point Shoe Co hopes to introduce a new type of Smart Shoe with even more advanced technology.
Shoe Co plans to use life cycle costing to work out the total production cost of the Smart Shoe and the total estimated profit for the two-year period.
Shoe Co has spent $5·6m developing the Smart Shoe. The time spent on this development meant that the company missed out on the opportunity of earning an estimated $800,000 contribution from the sale of another product.
The company has applied for and been granted a ten-year patent for the technology, although it must be renewed each year at a cost of $200,000.
The costs of the patent application were $500,000, which included $20,000 for the salary costs of Shoe Co’s lawyer, who is a permanent employee of the company and was responsible for preparing the application.
The following information is also available for the next two years:
| Year 1 | Year 2 | |
|---|---|---|
| Sales volumes (units) | 280,000 | 420,000 |
| $ | $ | |
| Selling price per unit | 55 | 45 |
| Material cost per unit | 16 | 14 |
| Labour cost per unit | 8 | 7 |
| Note: A unit is a pair of shoes |
| Year 1 | Year 2 | |
|---|---|---|
| $m | $m | |
| Fixed production overheads | 1·6 | 2·2 |
| Selling and distribution costs | 0·6 | 0·9 |
| Environmental costs | 0·1 | 0·15 |
| Year 1 | Year 2 | ||
|---|---|---|---|
| Expected cost | Probability | Expected cost | Probability |
| ($m) | ($m) | ||
| 2·2 | 0·2 | 1·8 | 0·3 |
| 2·6 | 0·5 | 2·1 | 0·4 |
| 2·9 | 0·3 | 2·3 | 0·3 |
Required:
Applying the principles of life cycle costing, calculate the total expected profit for Shoe Co for the two-year period. (10 marks)