Problem 1: Considering Suspending Production of a Product:
Pocahontas Chemical Industries, (PCI) manufactures a chemical compound, called PCI-608 that is used in the carbon-fiber industry. The company normally produces and sells 40,000 gallons of PCI-608 per month. However PCI's primary customer for this product, Chesapeake Marine Products, is planning to shut down its plant for a major re-tooling. During this re-tooling, which is expected to take two-months, PCI expects sales of PCI-608 to drop to only 13,000 gallons per month. Due to the shutdown PCI is considering suspending the production of PC1-608 while Chesapeake Marine Products completes its re-tooling.
The following data are available for PCI-608:
Selling price per gallon $35
Variable manufacturing cost per gallon 23
Fixed manufacturing overhead per month 250.000
Fixed selling costs per month 300,000
The company estimates that if production of PC1-608 is suspended, them fixed overhead costs can be reduced by $52,000 per month and fixed selling costs can be reduced by 15%. However, if PCI suspends production of PC1- 608, the company will need to incur a one-time cost of $14,000 to restart its production. PCI produces its products to-order, so it does not maintain any inventory.
Required:
a. Based on the information provided, determine the effects on PCI's net earnings, for the two-month period if it suspends production of PCI-608. Show supporting computations in good form.
b. At what level of sales, for the entire two-month period, would PCI be indifferent as to whether it keeps producing PCI-608, or suspends production? In other words, what is the minimal number of gallons that PCI must sell over the two month period to justify continuing production of PCI 608 while Chesapeake shuts down its plant? Show supporting computitions in good form.
Problem 2: Make or Buy a Component
Poe Pen Company produces various pens in a wide range of styles and prices. Its cheapest model is a ballpoint pen called Lenore, which it sells to retailers for $14.50 per box of 12 pens. This pen is made up of four separate parts, one of which is the ink cartridge. Poe is currently manufacturing these pens completely in-house, but it has received an offer from an outside company to supply the cartridge for $1.35r do n. Poe is considering this offer because it is currently producing and selling its maximum capacity of 100,000 boxes of the Lenore model. Poe's capacity is limited due to its ability to produce no more than 1,200 000 cartridges per year. However, it does have the capacity to produce more than 1.200,000 units of the other pen components. The cost to make one box containing one dozen pens, completely in-house, is shown below. Note that these costs are for the entire pen not just the ink cartridge.
Direct materials $4.20
Direct labor 2.60
Manufacturing overhead (fixed and variable) 2.30
Total cost per box $9.10
This includes fixed and variable manufacturing costs, and it is based on the assumption that 100 000 boxes of pens will be produced each year. Total fixed manufacturing costs are $140,000 per year.
If the offer from the outside supplier is accepted, Poe expects that its in-house direct materials cost will be reduced by 20%; direct labor and variable costs will be reduced by 10%.
Required:
a. Based on the information provided, what will be the effect on Poe's earnings, per year, if it accepts the offer from the outside supplier? Show supporting computations in good form.
b. Assume that Poe is confident it can increase its sales of Lenore to 150,000 boxes (1,800,000 pens). However, in order to produce 1,800,000 cartridges in-house, it will need to increase spending on fixed costs by $80,000 per year. Furthermore, the outside supplier who has offered to sell Poe cartridges at $1.35 per box (12 cartridges) requires a minimal-it order of 100,000 boxes.
Assume that if these pens are produced they can be sold at the current selling price of $14.50 per box, and that all other costs not discussed above will remain as they are currently.
Under these revised assumptions, should Poe spend the additional $80,600 per-year on fixed costs and continue to produce the pens completely in-house, or should it accept the outside supplier's offer to provide cartridges at $1.35 per box? Assume the company will make its decision based solely on which option maximizes earnings. Show supporting computations in good form.
Problem 3: Problem Sell or Process Further
Hannover Honey Company (HHC) buys honeycombs from beekeepers for $3:00 per pound. The company produces in the following manner. First, the raw honey is separated from the wax honeycombs. The wax is melted, cleaned, and formed into one-pound blocks that are sold for $2.25. Most of the raw honey is sold as is, for $4.60 per pound, but some is processed further into a third product, candy. The candy is called Honey-Drops, and it is sold foi $6.50 per box.
Due to recent changes in the market, and consumer habits, sales of Honey-Drops have been declining, and the company is trying to decide if production should continue. If HHC stops making the candy, it is sure it can sell all of the raw honey that would have been used in candy production.
Each box of Honey-Drops uses three-fourths pound of raw honey. Other costs incurred to make the candy, besides the raw honey, are shown below.
Variable Manufacturing Cost per box
Packaging $0.60
Other ingredients 0.40
Direct labor 0.30
Variable manufacturing overhead 0.15
Total $1.45
Fixed manufacturing costs per month are:
Candy maker's salary $5,000
Depreciation on equipment 600
Total $5.600
The candy maker only works on candy production. The depreciation relites to specialized equipment that is used only for making Honey-Drops, and it has no resale value.
In addition to the manufacturing costs above, Honey-Drops has a dedica d salesperson who is paid a salary of $2,500 per month, plus a commission of 6% of sales.
You are not told how many boxes of Honey-Drops HHC sells per month You do not need this information to work the problem.
Required:
a. Assume the company is committed to continuing the production of candy, even if it does not increase profits. What is the incremental (marginal) contribution margin per box of candy, versus selling the raw honey that goes into it? In other words, how much does HHC's profit increase or decrease if it converts three-fourths of a pound of honey int a box of candy, versus simply selling the raw honey? Show computations in good form.
b. Assume HHC is willing to discontinue Honey-Drops if doing so woul increase the company's overall profit. What is the minimum number of boxes of candy that EIFIC must sell each month to justify the continued production of Honey-Drops, versus simply sellingithe raw honey? Show computations in good form.
Problem 4 Evaluating Investment Centers:
RVA Appliances, LLC, sells appliances such as refrigerators and washing machines, as well as providing repair services for most household appliances. The company operates three different stores, which are treated as investment centers for the purposes of financial evaluation. The dal below pertain to the most recent accounting period.
Stores
Richmond Henrico Chesterfield
Sales $9,500,000 $ I2,750 000 $3,250000
Segment markilearningsl before taxes 450,000 820,000 145 000
Operatingaimingsfor EVA after taxes 360,000 670,000 110,000
Book value of average operating assests 3,200,000 5 400,000 900 000
Invested assets for EVA calculations 3,500,000 5,700,000 920,000
Minimum desired ROI 13% 15% 14%
Cost of capital 11% 11% 11%
Required:
a. Use the operating margin x assets turnover method (DuPont method) to calculate the ROI for each division. Show the answers for the margin, turnover, and ROI ser arately.
b. Identify which division appears to be performing the best based on their ROls, and provide} an explanation(s) as to why this is happening.
c. Calculate the residual income for each division.
d. Identify which division appears to be performing the best based on theiL residual incomes. ,
e. Calculate the "economic value added" for each division.
f. Identify which division appears to be performing the best based on EVA analysis.