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11-37 Make or Buy The Midwest Division of the Paibec Corporation manufactures subassemblies used in Paibec's final products. Lynn Hardt of Midwest 's profit planning department has - assigned the task of determining whether Midwest should continue to manufacture a subassembly component, MTR-2000, or purchase it from Marley Company, an outside supplier. Marley has submitted a bid to manufacture and supply the 32,000 units of MTR-2000 that Paibec will need for 2013 at a unit price of $17.30. Marley has assured Paibec that the units will be delivered according to Paibec's production specifications and needs. The contract price of $17.30 is applicable only in 2013, but Marley is interested in entering into a long-term a arragement beyond 2013. Lynn has submitted the following information regarding Midwest's cost to manufacture 30,000 units of MTR-2000 in 2012: Direct materials $195,000 Direct labor 120,000 Factory space rental 84,000 Equipment leasing costs 36,000 Other manufacturing costs 225,000 Total manufacturing costs $660,000 Lynn has collected the following information related to manufacturing MTR-2000: • Equipment leasing costs represent special equipment used to manufacture MTR-2000. Midwest can terminate this lease by paying the equivalent of one month's lease payment for each of the two years left on its lease agreement. • Forty percent of the other manufacturing overhead is considered variable. Variable overhead changes with the number of units produced, and this rate per unit is not expected to change in 2013. The fixed manufacturing overhead costs are not expected to change whether Midwest manufactures or purchases MTR-2000. Midwest can use equipment other than the leased equipment in its other manufacturing operations. • Direct materials cost used in the production of MTR-2000 is expected to increase 8% in 2013. • Midwest's direct labor contract calls for a 5% wage increase in 2013. • The facilities used to manufacture MTR-2000 are rented under a month-to-month rental agreement. Midwest would have no need for this space if it does not manufacture MTR-2000. Thus, Midwest can withdraw from the rental agreement without any penalty. John Porter, Midwest divisional manager, stopped by Lynn's office to voice his opinion regarding the outsourcing of MTR-2000. He commented , "I am really concerned about outsourcing MTR- 2000. I have a son-in-law and a nephew, not to mention a member of our bowling team, who work on MTR-2000. They could lose their jobs if we buy that component from Marley. I really would appreciate anything you can do to make sure the cost analysis shows that we should con- tinue making MTR-2000. Corporate is not aware of materials cost increases and maybe you can leave out some of those fixed costs. I just think we should continue making MTR-2000." Required 1. Prepare a relevant cost analysis that shows whether the Midwest Division should make MTR-2000or purchase it from Marley Company for 2013. 2. Identify and briefly discuss the strategic factors that Midwest should consider in this decision. 3. By referring to the specific ethical standards for management accountants outlined in Chapter 1, assess the ethical issues in John Porter's request of Lynn Hardt. 11-43 Profitability Analysis; Pro Forma Income Statement RayLok Incorporated has invented a secret process to improve light intensity and manufactures a variety of products related to this process. Each product is independent of the others and is treated as a separate profit/loss division . Product (division) managers have a great deal of freedom to manage their divisions as they think best. Failure to produce target division income is dealt with severely; however, rewards for exceeding one's profit objective are, as one division manager described them, lavish. The DimLok Division sells an add-on automotive accessory that automatically dims a vehicle's headlights by sensing a certain intensity of light coming from a specific direction. DimLok has had a new manager in each of the three previous years because each manager failed to reach RayLok 's target profit. Donna Barnes has just been promoted to manager and is studying ways to meet the current target profit for DimLok. DimLok's two profit targets for the coming year are $800,000 (20% return on the invest- ment in the annual fixed costs of the division) plus an additional profit of $20 for each DimLok unit sold. Other constraints on division's operations are • Production cannot exceed sales because RayLok's corporate advertising program stresses completely new product models each year, although the models might have only cosmetic changes. • DimLok's selling price cannot vary above the current selling price of $200 per unit but may vary as much as 10% below $200. • A division manager can elect to expand fixed production or selling facilities; however, the target objective related to fixed costs is increased by 20% of the cost of such expansion. Furthermore, a manager cannot expand fixed facilities by more than 30% of existing fixed cost levels without approval from the board of directors. Donna is now examining data gathered by her staff to determine whether DimLok can achieve its target profits of $800,000 and $20 per unit. A summary of these reports showsthe following: • Last year's sales were 30,000 units at $200 per unit. • DimLok 's current manufacturing facility capacity is 40,000 units per year but can be increased to 80,000 units per year with an increase of $1,000,000 in annual fixed costs. • Present variable costs amount to $80 per unit, but DimLok 's vendors are willing to offer raw materials discounts amounting to $20 per unit, beginning with unit number 60,001. Sales can be increased up to 100,000 units per year by committing large blocks of product to institutional buyers at a discounted unit price of $180. However, this discount applies only to sales in excess of 40,000 units per year. Donna believes that these projections are reliable and is now trying to determine what DimLok must do to meet the profit objectives that RayLok's board of directors assigned to it. Required 1. Determine the dollar amount of DimLok 's present annual fixed costs. 2. Determine the number of units that DimLok must sell to achieve both profit objectives. Be sure to consider all constraints in determining your answer. 3. Without regard to your answer in requirement 2, assume that Donna decides to sell 40,000 units at $200 per unit and 24,000 units at $180 per unit. Prepare a budgeted income statement (contribu- tion format) for DimLok showing whether her decision will achieve DimLok 's profit objectives. 4. Assess DimLok 's competitive strategy. 5. Identify critical success factors associated with the strategy that DimLok is pursuing 12-47 Basic Capital-Budgeting Techniques; No Taxes, Uniform Net Cash Inflows; Spreadsheets Nelson, Inc., purchased a $500,000 machine to manufacture specialty taps for electrical equipment. e\.son expects to sell all it can manufacture in the next 10 years. To encourage capital investments, the government has exempted taxes on profits from new investment. This legislation is to be in effect in the foreseeable future. The machine is expected to have l0-year useful life with no salvage value. Nelson uses straight-line depreciation. The net inflow is expected to be $120,000 each year for 10 years. Nelson uses a 12% discount rate in evaluating capital investments. Assume, for simplicity, that MACRS depreciation rules do not apply. Required Using Excel, compute forthe proposed capital investment the: 1. Payback period under the assumption that cash inflows occur evenly throughout the year. 2. Book rate of return based on (a) initial investment and (b) average investment. 3. Net present value (NPV) of the proposed investment under the assumption that cash inflows at year-end. 4.Present value payback period of the proposed investment under the assumption that cash inflows occur evenly throughout the year. 5-Internal rate of return (IRR). 6- Modified internal rate of return (MIRR). 9-42 CVP Analysis; Sensitivity Analysis; Multiple Products GoGo Juice is a combination gas station and convenience store located at a busy intersection. Recently a national chain opened a similar store only a block away; consequently, sales have decreased for GoGo. In an effort to reclaim lost sales, GoGo has implemented a promotional effort; for every $10 purchase at GoGo, the customer receives a $1 coupon that can be redeemed toward the purchase of gasoline. The average gasoline customer purchases 15 gallons of gasoline at $2.50/gal. The results of an average month, prior to this coupon promotion, are shown below. Not included in the information presented below is the monthly cost of printing the COUJX1 which is estimated to be $500. Coupons are issued on the basis of total purchases regardless of whether the purchases are paid in cash or paid by redeeming coupons. Assume that coupons are distributed to customers for 75% of the total sales. Also assume that all coupons distributed used to purchase gasoline. Sales Cost of Sales (perunitor%ofretail) Gasoline $100,000 $1.875 pergallon Food and beverages 60,000 60% Other products 40,000 50% Other cost Labor-station attendants 10000$ Labor-supervision 25000 Rent,power,supplies,interest,andmisc. 40000 Depreciation (pumps, computers, counters, fixtures, and building) 7500 Required 1.If GoGo Juice implements the promotional coupon effort, calculate the profit (loss) before tax the sales volume remains constant and the coupons are used to purchase gasoline. Assume the sales mix remains constant. Prepare a contribution income statement to support your answer. 2. Calculate the breakeven sales (in dollars) for GoGo Juice if the promotional effort is implemented Assume that the product mix remains constant. Use the weighted-average contribution margin· ratio approach to generate your answer. (Hint: Sales mix for this purpose is defined on the basis relative sales dollars, not units.) 3. Based on the assumed sales mix (determined on the basis of relative sales dollars, not units), determine the breakdown of total breakeven sales dollars across the three product lines: gas; food and beverages; and other products. (Round your answers to whole dollars.) 4. Disregarding your responses to requirements 1 and 2, assume the weighted-average contribution margin ratio, after implementation of the coupon program, is 35%. Calculate the profit (loss) before tax for GoGo Juice, assuming sales increase 20% due to the new program. Assume that the sales mix in terms of relative sales dollars remains constant. 5. GoGo Juice is considering using sensitivity analysis in combination with cost-volume-profit (CVP) analysis. Discuss the use of sensitivity analysis in conjunction with CVP analysis. Include in y - discussion at least three factors that make sensitivity analysis prevalent in decision-making. Provide a brief description of the methods that can be used to deal with uncertainty, as discussed in the chapter. $ 94.9 10-57 Budgets for a Service Firm Triple-F Health Club (Family, Fitness, and Fun) is a not-forprofit family-oriented health club. The club's board of directors is developing plans to acquire more equipment and expand club facilities. The board plans to purchase about $25,000 of new equipment each year and wants to establish a fund to purchase the adjoining property in four or five years. The adjoining property has a market value of about $300,000. The club manager, Jane Crowe, is concerned that the board has unrealistic goals in light of the club's recent financial performance. She has sought the help of a club member with an account-ing background to assist her in preparing a report to the board supporting her concerns. The member reviewed the club'srecords, including this cash-basis income statement: Cash revenues: TRIPLE-FHEALTH CLUB IncomeStatement(CashBasis) For Years Ended October 31 (in thousands) 2014 2013 Annual membership fees Lessonand classfees Miscellaneous Total cash revenues Cash expenses: $355. 0 234. 0 2.0 $591.0 $300. 0 180. 0 1.5 $481.5 Manager's salary and benefits Regular employees' wages and benefits Lesson and class employees' wages and benefits Towels andsupplies Utilities (heat and light) Mortgage interest $36.0 $ 36.0 190.0 190.0 195.0 150.0 16.0 15.5 22.0 15.0 35.1 37.8 Miscellaneous 2.0 - 1.5 Total cash expenditures Increase in cash $496.1 $445.8 $ 35.7 • Other financial information as of October 31, 2014: • Cash in checking account, $7,000. Petty cash, $300. Outstanding mortgage balance, $360,000. Accounts payable arising from invoices for supplies and utilities that are unpaid as of October 31, 2014, and due in November 2014, $2,500. • No other unpaid bills existed on October 31, 2014. • The club purchased $25,000 worth of exercise equipment during the current fiscal year Cash of $10,000 was paid on delivery, with the balance due on October 1. This amount had not been paid as of October 31, 2014. An additional $25,000 (cash) of equipment purchase is planned for the coming year. • The club began operations in 2010 in rental quarters. In October 2010, it purchased its crent property (land and building) for $600,000, paying $120,000 down and agreeing to pay $30,000 plus 9% interest annually on the unpaid loan balance each November 1, starting November 1, 2011. • Membership rose 3% in 2014. The club has experienced approximately this same annual growth rate since it opened and this rate is expected to continue in the future. • Membership fees increased by 15% in 2014. The board has tentative plans to increase theses fees by 10% in 2015. • Lesson and class fees have not been increased for three years. The board policy is to encourage classes and lessons by keeping the fees low. The members have taken advantage of this policy, and the number of classes and lessons has increased significantly each year. The club expects the percentage growth experienced in 2014 to be repeated in 2015. • Miscellaneous revenues are expected to grow at the same rate as in 2014. • Operating expenses expected to increase: Hourly wage rates and the manager's salary: 15%. Towels and supplies, utilities, and miscellaneous expenses: 25%. Required 1. Prepare a cash budget for 2015 for the Triple-F Health Club. 2. Identify any operating problems that this budget discloses for the Triple-F Health Club. Explain your answer. 3. Is Jane Crowe's concern that the board's goals are unrealistic justified? Explain your answer. 13-48 Life-Cycle Costing Tim Waters, the COO of BioDerm, has asked his cost management te for a product-line profitability analysis for his firm's two products, Xderm and Yderm. T..._ two skin care products require a large amount of research and development and advertising After receiving the following statement from BioDerm's auditor, Tim concludes that Xderm the more profitable product and that perhaps cost-cutting measures should be applied :_ Yderm Xderm "derrn lotal Required 1. Explain why Tim may be wrong in his assessment of the relative performance of the two products. 2. Suppose that 80% of the R&D and selling expenses are traceable to Xderm. Prepare life-cycle income statements for each product. What does this tell you about the importance of accurate life- cycle costing? 3. Consider again your answers in requirements 1 and 2 with the following additional information. R&D and selling expenses are substantially higher for Xderm because it is a new product. Tim has strongly supported development of the new product, including the high selling and R&D expenses. He has assured senior managers that the Xderm investment will pay off in improved profits for the firm. What are the ethical issues, if any, facing Tim as he reports to top management on the profit- ability of the firm's two products? Sales $3,000,000 $2,000,000 $5,000,000 Costof goods sold (1,900,000 ) I 1,600,000) (3,500,000) Grossprofit $1,100,000 $ 400,000 $1,500,000 Research and development (900,000) Selling expenses (100,000) Profit beforetaxes $ 500,000

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