1. Several months ago during the marketing staff meeting, the international sale

ID: 2494865 • Letter: 1

Question

1. Several months ago during the marketing staff meeting, the international sales manager of a mid- sized manufacturer of automotive parts reported that beginning next year, and a major customer was going to require its suppliers to be ISO 14001 certified. Further discussion by the group indicated that several other customers had suggested they also were considering requiring ISO 14001 certification. Because of these concerns a committee was appointed to study the certification matter and to report on its potential impact on the company. Last week the ISO 14001 study committee report was received by the marketing staff. The report contained the following findings and recommendations: 1. The company that will require its suppliers to be certified is a major customer. Its purchases amounted to $129 million last year, or 15% of the company's total sales revenue of $800 million. 2. Three other companies will very likely make the same requirement within the next three years. Their combined purchases were $160 million last year. 3. Obtaining ISO preliminary certification would take six months or more and the paper work would cost about $500,000. Plant modifications and processing changes to meet certification requirements were estimated to require the purchase of $50 million of equipment corresponding to a total capital cost of about $91.6 million. O&M for this equipment would be $15 million per year. 4. Last year before tax earnings were 16% of sales, so cancellation of the $120 million of sales contract by the major customer would amount to a $19.2 million per year reduction in earnings.

Given this information: a. What would be the total annual cost to the company of ISO 14001 certification? Use i = 6% and n=8 years for capital recovery calculations. (10 pts)

b. What would be the payback period if ISO certification was obtained and the major customer retained? (10 pts)

Explanation / Answer

The required table is as below:

Paper work

$500,000

Add: Capital cost

$91,600,000

Investment cost (I)

$92,100,000

O&M

$15,000,000

Reduction in earnings

$19,200,000

Cost per year (C)

$34,200,000

Total sales $(129 + 160) million

$289,000,000

Profit (Sales × 16%)

$46,240,000

Benefit (Profit – C)

$12,040,000

Total annual cost = (Cost per year) × (6% accumulated factors till 8th year)

= $34,200,000 × 0.6274

= $21,457,080

Payback period = (Investment cost) / Benefit

= $92,100,000 / $12,040,000

= 7.65 years