Capacity Utilization
Response to the following problem:
HiTek Industries spends $20,000 per year on Component A. NewIdea Co. has a product that can be used instead of Component A, and it would cost HiTek $30,000 per year, compared to HiTek's current costs for Component A of $20,000 per year. NewIdea believes that it can justify the additional price through productivity improvements.
NewIdea's sales representative visits HiTek and is able to determine that HiTek has a maximum capacity of 25,000 units per year. The sales price is $100 per unit and the contribution margin is 30%. HiTek has currently been experiencing a 7.5% scrap rate and a 7.5% downtime rate. NewIdea's product is expected to reduce scrap to 5% and downtime to 5%.
a. Produce a financial justification that will support NewIdea's proposal, assuming that NewIdea's products will reduce the downtime and waste to the target levels.
b. If you received such a proposal from NewIdea, what would you want to be sure of before accepting it?