Dairy products Ltd has recently developed sales of cream in aerosol dispensers which are sold alongside the company's traditional products of cartons of cream and packets of cheese. The company is now considering the sale of cream cheese in aerosol dispensers.

It is a company policy that any new products must be capable of generating sufficient profit to cover all costs, including estimated initial marketing and advertising expenditure of 1,000,000

Currently weekly production, with unit costs and selling prices, is as follows:

	Output units	Variable cost	Fixed cost	Selling price
Cartons of cream	400,000	0.45	0.15	0.75
Aerosol cans of cream	96,000	0.50	0.25	1.05
Packets of cheese	280,000	1.00	0.20	1.30

Sales volume is equal to production volume. A 50 week trading year is assumed. Rates of absorption of fixed costs are based on current levels of output.

In order to produce cream cheese in aerosol dispensers, the aerosol machine would require modification at a cost of 400,000 which is to be recovered through sales within one year. Additional annual fixed costs of 500,000 would be incurred in manufacturing the new product. Variable cost of production would be 50p per can. Initial research has estimated that contribution will be maximised at a price of 1.40 per can, which is expected to lead to a weekly demand of 80,000 cans.

There is adequate capacity on the aerosol machine, but the factory is operating near capacity in other areas. The new product would have to be produced by reducing production elsewhere and two alternatives have been identified

(a) reduce production of cream cartons by 20% per annum: or

(b) reduce production of packet cheese by 25% per annum.

The directors consider that the new product must cover any loss of profit caused by this reduction in volume. They are also aware that market research has shown growing customer dissatisfaction because of wastage with cream sold in cartons.

Required

Prepare a memorandum to the board of directors of Dairy products Ltd. showing, with relevant calculations, the outcome of the alternative courses of action open to the company and make a recommendation on the most profitable.