Losing patent protection on the blue pill. BRG Pharmaceutical produces three pills: Blue, Red and Green. Blue is the oldest of their products and has the highest volume of production and sales. Red and Green were introduced a few years ago. Blue is characterized for being more labor intensive than the other two products. However, Red and Green rely on automatized technology that requires a higher investment in production equipment. The cost structure for each product is as follows: direct materials, direct labor and allocated overhead. The company has identified the following three types of overhead: Equipment costs per product (incurred only if the product is manufactured) $100,000 90,000 Building costs (allocated based on equipment costs) Corporate overhead (allocated based on production volume) Total Overhead Costs 500,000 $690,000 Recently the profit margin per unit on the blue pill dropped below the 10% minimum required by BRG. BRG's management is concerned that the blue pill profit margin will continue to underperform because the product will lose its patent protection in the upcoming year. Management has put together exhibits 1, 2 and 3 to try to understand the impact of the loss of patent protection on the blue pill. Note that the market price on the blue pill is likely to fall below the current price because of the introduction of generic versions of the blue pill by other companies. Required: Compare exhibits 1 and 2 and discuss why the drop in volume on the blue pill affects not only its profit margin but also the profit margins of both the red and the green pill. Compare exhibits 1 and 3 and discuss why eliminating the blue pill reduces the profitability on the remaining products. What would you recommend management to do given the information presented in the exhibits? Exhibit 2: Drop in volume due to loss of patent protection on blue Volume Blue 800,000 Red Green 300,000 500,000 Price 1.60 4.00 2.50 Direct Materials per unit 100 $ 2.00 $ 1.50 Direct Labor per unit 0.25 010 0.05 Allocated Overhead Cost per unit 036 063 043 Total Cost per unit 161 273 198 (001) 1.27 052 Profit percentage per unit -1% 32% 21% Overhead Costs Blue Red Green Total Equipment 20,000 50,000 30,000 100,000 Building 18,000 45,000 27,000 90,000 Corporate Overhead 250,000 93,750 156,250 500,000 $ 288,000 $188,750 $213,250 $ 690,000 Exhibit 3: Elimination of bluepill dueto patent protection Volume Price Direct Materials per unit Direct Labor per unit Allocated Overhead Cost per unit Total Cost per unit Profit percentage per unit Overhead Costs Equipment Building Corporate Overhead Blue Red Green 300,000 500,000 4.00 2.50 2.00 $ 1.50 010 0.05 098 0.75 3.08 2.30 092 0.20 23% 8% Blue Red Green Total 50,000 30,000 80,000 56,250 33,750 90,000 187,500 312,500 500,000 $ 293,750 $ 376,250 $ 670,000 ACG 3341 Inventory Costing Exhibit 1: Market Projection not considering loss of patent protection on blue pill Volume Price Blue 1,200,000 Red 300,000 Green 500,000 160 - 4.00 2.50 Direct Materials per unit 100 $ 2.00 $ 1.50 Direct Labor per unit 0.25 0.10 0.05 Allocated Overhead Cost per unit 028 0.57 0.36 Total Cost per unit 153 $ 2.67 $ 191 Profit per unit $ 0.07 $ 133 $ 0.59 Profit percentage per unit 4% 33% 23% Jimnez-Angueira Overhead Costs Blue Red Green Total Equipment 20,000 $ 50,000 $30,000 $ 100,000 Building 18,000 45,000 27,000 90,000 Corporate Overhead 300,000 75.000 125,000 500,000 338,000 $170,000 $182,000 $ 690,000