Mildred Goates, CEO of Wellington Circuits, was concerned about another price decrease for the coming year to maintain the company's annual sales volume of integrated circuit boards. The current selling price of $18 per unit was producing a $2-per-unit profit-half the customary $4-per-unit profit. To match the latest reduc- tion by competitors would reduce the price from $18 to $14. This would put the price below the cost to produce and sell it. Determined to find a solution, Mildred had her controller gather the following information on Wellington's activities and costs:
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Batch-level activities:
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Setting up equipment
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$ 125,000
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Materials handling
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180,000
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Inspecting products
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122,000
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Product-sustaining activities:
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Engineering support
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120,000
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Handling customer complaints
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100,000
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Filling warranties
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170,000
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Storing goods
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80,000
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Expediting goods
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75,000
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Unit-level activities:
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Using materials
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500,000
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Using power
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48,000
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Manual insertion labora
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250,000
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Other direct labor
Total costs
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150,000
$1,920,000b
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a. Diodes, resistors, and integrated circuits are inserted manually into the circuit board.
b. This total cost produces a unit cost of $16 for last year's sales volume.
The controller expressed the belief that per-unit costs can be reduced by at least $7. Mildred was excited by this possibility, because decreasing the price to $12 would increase Wellington's market share (sales volume) for the boards by 50 percent.
Required
1. Identify as many non-value-added costs as possible. Compute the cost savings per unit that would be realized if these wasteful costs were eliminated. Was the controller correct in his preliminary cost reduction assessment? Discuss actions that the company can take to reduce or eliminate the wasteful non-value-added activities.
2. Compute the target cost required to maintain current market share, while earning a profit of $4 per unit. Now compute the target cost required to expand sales by 50 percent. How much cost reduction would be required to achieve each target?
3. Assume that further activity analysis revealed the following: switching to automated insertion would save $60,000 of engineering support and $90,000 of direct labor. Now, what is the total potential cost reduction per unit available from activity analysis? With these additional reductions, can Wellington Circuits achieve the target cost to maintain current sales? To increase it by 50 percent?
4. Calculate income based on current sales, prices, and costs. Now, calculate the income using a $14 price and a $12 price, assuming that the maximum cost reduction possible is achieved (including Requirement 3's reduction). What price should be selected?