Shut down decision

**Question:**

**EcoTech Appliances Ltd.** is a medium-sized company producing smart home devices. The company has recently introduced an **AI-controlled air purifier**, targeting health-conscious consumers. The product has a projected life cycle of **5 years**, and management wants to assess its long-term profitability and decide whether to continue production after the second year.

The following information has been provided by the Finance Department:

* **Research and development costs (Year 0):** £3,600,000
* **Selling price per unit:** £900
* **Estimated annual sales volume:**

* Year 1: 4,000 units
* Year 2: 6,000 units
* Year 3: 7,000 units
* Year 4: 5,000 units
* Year 5: 3,000 units
* **Production cost per unit:**

* Direct material: £320
* Direct labour: £180
* Variable overhead: £120
* **Annual fixed production overhead:** £1,200,000
* **Marketing and advertising cost (Years 1–3):** £1,500,000 in total
* **Disposal and winding-up cost (Year 5):** £400,000

**Additional Information:**
i) A new competitor is expected to enter the market at the **beginning of Year 3**, reducing expected sales volume by **25%** in Years 4 and 5.
ii) Management plans to **review performance at the end of Year 2** to decide whether production should continue.

**Required:**
Using a suitable **relevant cost and decision-making technique (make-or-discontinue analysis)**, evaluate whether EcoTech Appliances Ltd. should **continue production beyond Year 2**, taking into account the competitor’s market entry and its impact on sales and profitability.

If the company continues production in Years 3 and 4, the total contribution will be calculated as:
(8,000 + 5,600) × (£800 ? £550) = £3,400,000.
From this amount, the fixed production overhead for two years (£1,500,000 × 2 = £3,000,000) and the disposal cost of £500,000 must be deducted.
Therefore, the incremental profit from continuing production is £100,000.

If the company decides to stop production after Year 2, it will lose the contribution of £3,400,000. However, it will save the fixed production overhead for two years (£3,000,000) and the disposal cost of £500,000.
As a result, the company would experience an incremental loss of £100,000 if it discontinues production.

Should I include disposal cost in the calculation?