Traffic Paint Currently, Wellesley has the traffic paint contracts for the state
ID: 1170742 • Letter: T
Question
Traffic Paint
Currently, Wellesley has the traffic paint contracts for the states of Pennsylvania, North Carolina,
Delaware, and Virginia. Of last year’s total production of 380,000 gallons, 90% was traffic
paint. Of this amount, 88,000 gallons were for the Virginia contract. Each state has unique specifications
for color, thickness, texture, drying time, and other characteristics of the paint. For example,
paint sold to Pennsylvania must withstand heavy use of salt on roads during the winter.
Paint for North Carolina highways must tolerate extended periods of intense heat during summer
months.
The process of bidding on a traffic paint contract begins with a road test under the supervision
of the National Association of Highway Paints (NAHP), an independent organization supported
by state funds. NAHP designates a certain stretch of highway to serve as the road test site.
Any paint manufacturer may apply stripes of their paint at the test site. NAHP monitors the test
site and reports the results to the state highway department. State personnel review the reports
and invite the manufacturers of the best-performing paints to submit bids. The firm that submits
the lowest bid wins the contract.
Contracts, which normally cover a five-year period, specify only the price per gallon and
quality requirements such as drying time and road-life. The timing of deliveries is determined
later based on state work schedules and weather constraints. Demand is highly seasonal, as states
do most of their highway painting in June, July, and August. The total amount of paint a state will
order is not determined until spring, when the states know how much of their highway budget
remains after winter snow removal costs have been paid.
After the paint is produced, the state must test the paint before approving it for shipment. A
sample is sent to the state laboratory, which may take up to two months to perform the testing. In
the meantime, Wellesley must store all the manufactured paint in its warehouse. At times, the
warehouse has been filled to capacity, and drums of paint are stored in the aisles, production
areas, and any available inch of space.
Due to the high cost of shipping paint, most paint producers can be competitive on price
only in locations fairly close to their production facilities. Accordingly, Wellesley has enjoyed an
advantage in bidding on contracts in the eastern states close to Virginia. However, one of their
biggest competitors, Heron Paint Company of Houston, Texas, is building a new plant in North
Carolina. With lower costs due to their efficient new facility and their proximity, Heron will become
a major competitive threat.
Commercial Paint
Wellesley’s commercial paint line includes interior and exterior house paints in a wide range
of colors formulated to approximate authentic colonial colors. Because of the historical association,
the line has been well received in Virginia. Most of these paints are sold through paint and
hardware stores as the stores’ second or third line of paint. The large national firms such as Benjamin
Moore or Sherwin Williams provide extensive services to paint retailers such as computerized color matching equipment. Partly because they lack the resources to provide such amenities
and partly because they have always considered the commercial paint a sideline, Wellesley has
never tried to market their commercial line aggressively.
Mrs. W. is worried about the future of the company. The firm’s strategic goal is to provide a
quality product at the lowest possible cost and in a timely fashion. After absorbing the shock of
losing the Virginia contract, Mrs. W. wondered whether the firm should consider increasing production
of commercial paints to lessen the company’s dependence on traffic paint contracts. Her
son, who manages the day-to-day operation of the firm, believes they can double their sales of
commercial paint if they undertake a promotional campaign estimated to cost $15,000. The average
price of traffic paint sold last year was $9 per gallon. For commercial paint, the average price
was $11.
Cost Data
Charlie Oliver has assembled the following data to evaluate the financial performance of the
two lines of paint. The primary raw material used in paint production is latex. The list price for
latex is $13.50 per pound. If the firm uses more than 150,000 pounds annually they qualify for a
10% discount; 450 pounds of latex are needed to produce 1,000 gallons of traffic paint. Commercial
paint requires 325 pounds of latex per 1,000 gallons of paint. In addition to the cost of the
latex, other variable costs are as shown below.
Raw materials cost per gallon of paint: Traffic Commercial
Camelcarb (limestone) 0.38 0.54
Silica 0.37 0.52
Pigment 0.12 0.38
Other ingredients 0.06 0.03
Direct labor cost per gallon 0.46 0.85
Freight cost per gallon 0.78 0.43
Last year, overhead costs attributable to the traffic paint totaled $85,000, including an estimated
$25,000 of costs directly associated with the Virginia contract. Overhead costs attributable
to the commercial paint are $13,000. Other manufacturing overhead costs total $110,000. Charlie
estimates that $9,000 of this amount is inventory handling costs that will be avoided due to the
loss of the Virginia contract. Both the remaining manufacturing overhead and the general and
administrative costs of $140,000 are allocated equally to all gallons of paint produced.
Question:. Calculate the contribution margin (selling price minus variable costs) and gross margin
(selling price minus all manufacturing costs) per gallon for each type of paint and total firm-wide
profit under each of the following scenarios:
Scenario A Current production, including the Virginia contract
Scenario B Without either the Virginia contract or the promotion to expand sales of commercial
paint
Scenario C Without the Virginia contract but assuming the promotional campaign is undertaken
and sales of commercial paint do in fact double
What insight is provided by a comparison of Scenarios A and B? What insight is provided by
a comparison of Scenarios B and C?
Explanation / Answer
Sceanrio A & B comparison
Due to less use of latex, since the Virginia contract is lost, the firm lost the discount on latex. this added to cost of per gallon of latex. Without the virginia contract, the traffic paint division is operating at a loss. Commercial paint department is clearly more profitable than traffic paint. However the volume of traffic paint sale is more than commercial paint. For traffic paint depatmet to operate at aprofit they need to increase the sales. this will make them elgible for discount on latex.
Scenarios B& C
Even though the sale of commercial paint has doubled, the firm is still not eligible for latex discount. Theres is no change in contriibution per unit fromScenaio B to C. There was not enough increase in sales units to bring down the per unit variable cost.
Scenario A Traffic Commercial Total Production 342,000 38,000 380,000 Latex needed to produce 1000 gallons of paint 450 325 Latex needed 153,900 12,350 166,250 (342000/1000*450) (38000/1000*325) Cost per pound of latex (10% discount applicable) 12.15 12.15 Latex needed per gallon 0.45 0.33 Cost per gallon of paint 5.47 3.95 Camel carb 0.38 0.54 Silica 0.37 0.52 Pigment 0.12 0.38 Other Ingredients 0.06 0.03 Direct Labor per gallon 0.46 0.85 Freight cost per gallon 0.78 0.43 Total cost per gallon 7.64 6.70 Total Variable cost 2,612,025 254,553 2,866,578 Sales per gallon 9.00 11.00 Sales 3,078,000 418,000 3,496,000 Variable cost 2,612,025 254,553 2,866,578 Contribution 465,975 163,448 629,423 Contribution per gallon 1.36 4.30 1.66 Overhead cost 85,000 13,000 98,000 Other Manufacturing cost for virginia contract 9,000 - 9,000 Other Manufacturing allocated 90,900 10,100 101,000 Gross Margin 281,075 140,348 421,423 Gross Margin per gallon 0.82 3.69 1.11 General and Administrative Costs 126,000 14,000 140,000 Net Income 155,075 126,348 281,423Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.