EKY8-1 Business Decision Case Marvin Corporation manufactures both an automatic

Question

EKY8-1

Business Decision Case Marvin Corporation manufactures both an automatic and a manual

household dehumidifier. Because of limited demand, for several years production has been at 80%

of estimated capacity, which is thought to be limited by the number of machine hours available. At

current operation levels, a profit analysis for each product line shows the following:

Per-unit Data

Automatic Manual

Sales price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $350 $150

Production costs:

Direct material. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $65 $32

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 25

Variable manufacturing overhead. . . . . . . . . . . . . . . . . . . 68 16

Fixed manufacturing overhead . . . . . . . . . . . . . . . . . . . . . 50

$218 18 $ 91

Variable operating expenses . . . . . . . . . . . . . . . . . . . . . . . . 52 21

Fixed operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 30

13

Total cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300 $125

Operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50 $ 25

Management wants to make use of the company’s current excess capacity by increasing production.

Each unit of the automatic model requires 2.5 machine hours; the manual model requires 1 machine

hour per unit.

Required

Present answers for the following questions in each independent situation:

a. Assume that sufficient units of either product can be sold at current prices to utilize existing

capacity fully and that fixed costs will not be affected.

1. To which product should the excess capacity be devoted if the decision basis is maximi-

zation of contribution margin per unit of product?

2. Prepare an analysis showing which product line should be emphasized if the firm’s net

income is the decision basis.

3. What general decision guideline applies in this situation?

b. Suppose the excess capacity represents 10,000 machine hours, which can be used to make

4,000 automatic units or 10,000 manual units or any proportionate combination. The only

market available for these extra units is a foreign market in which the sales prices must be

reduced by 20% and in which no more than 6,000 units of either model can be sold. All

costs will remain the same except that the sales commission of 10% (included in the variable

operating expenses) will be avoided. Prepare an analysis showing which product should be

emphasized and the effect on the firm’s net income.

c. Assume that the excess capacity can be used as indicated in requirement (b) and that the

firm’s market research department believes that the production available from using the ex-

cess capacity exclusively on either model can be sold in the domestic market at regular prices

if a promotion campaign costing $225,000 is undertaken for the automatic model or $235,000

for the manual model. Prepare an analysis indicating for which product the campaign should

be undertaken.

EKY8-1. Business Decision Case Marvin Corporation manufactures both an automatic and a manual household dehumidifier. Because of limited demand, for several years production has been at 80% of estimated capacity, which is thought to be limited by the number of machine hours available. At current operation levels, a profit analysis for each product line shows the following: Per-unit Data Automatic Manual Sales price Production costs $350 $150 $65 35 68 $32 25 Direct material.. Variable manufacturing o $218 52 30 $300 $ 50 $ 91 21 Variable operating expenses Fixed operating expenses $125 $ 25 ncome. Management wants to make use of the company's current excess capacity by increasing production. Each unit of the automatic model requires 2.5 machine hours; the manual model requires 1 machine hour per unit. Required Present answers for the following questions in each independent situation: a. Assume that sufficient units of either product can be sold at current prices to utilize existing capacity fully and that fixed costs will not be affected. 1. To which product should the excess capacity be devoted if the decision basis is maximi zation of contribution margin per unit of product? Prepare an analysis showing which product line should be emphasized if the firm's net income is the decision basis 2. 3. What general decision guideline applies in this situation? Suppose the excess capacity represents 10,000 machine hours, which can be used to make 4,000 automatic units or 10,000 manual units or any proportionate combination. The only market available for these extra units is a foreign market in which the sales reduced by 20% and in which no more than 6,000 units of either model can be sold. All costs will remain the same except that the sales commission of 10% (included in the variable operating expenses) will be avoided. Prepare an analysis showing which product should be emphasized and the effect on the firm's net income. Assume that the excess capacity can be used as indicated in requirement (b) and that the firm's market research department believes that the production available from using the ex cess capacity exclusively on either model can be sold in the domestic market at regular prices if a promotion campaign costing $225,000 is undertaken for the automatic model or $235,000 for the manual model. Prepare an analysis indicating for which product the campaign should b. prices must be c.

Explanation / Answer

AUTOMATIC MANUAL SALES 350 150 PRODUCTION COSTS: DIRECT MATERIAL 65 32 DIRECT LABOR 35 25 VARIABLE MANUFACTURING OVERHEAD 68 16 FIXED MANUFACTURING OVERHEAD 50 218 18 91 VARIABLE MANUFACTURING EXPENSES 52 21 FIXED OPERATING EXPENSES 30 13 TOTAL COST 300 125 OPERATING INCOME 50 25 A. 1. DECISION BASIS IS CONTRIBUTION MARGIN PER UNIT. CALCULATION OF CONTRIBUTION MARGIN FOR EACH PRODUCT, CONTRIBUTION MARGIN=SALES-VARIABLE COST. AUTOMATIC MANUAL SALES 350 150 PRODUCTION COSTS: DIRECT MATERIAL 65 32 DIRECT LABOR 35 25 VARIABLE MANUFACTURING OVERHEAD 68 16 VARIABLE OPERATING EXPENSES 52 220 21 94 CONTRIBUTION MARGIN PER UNIT 130 56 50 19 IF PURPOSE IS TO MAXIMISE CONTRIBUTION MARGIN PER UNIT, AUTOMATIC HOUSEHOLD DEHUMIDIFIER SHOULD BE MADE. 2.DECISION BASIS IS THE FIRM'S NET INCOME. AUTOMATIC MANUAL SALES 350 150 PRODUCTION COSTS: DIRECT MATERIAL 65 32 DIRECT LABOR 35 25 VARIABLE MANUFACTURING OVERHEAD 68 16 VARIABLE OPERATING EXPENSES 52 220 21 94 CONTRIBUTION MARGIN PER UNIT 130 56 FIXED MANUFACTURING OVERHEAD 50 18 NET INCOME 80 38 IF PURPOSE IS TO MAXIMISE NET INCOME, AUTOMATIC HOUSEHOLD DEHUMIDIFIER SHOULD BE MADE. NOTE: FIXED OPERATING EXPENSES ARE NOT CONSIDERED WHILE CALCULATING NET INCOME AS IT IS CLEARLY SAID IN THE QUESTION THAT FIXED COSTS WILL NOT BE AFFECTED 3. GENERAL DECISION GUIDELINES APPLIES IN THIS SITUATION THAT FIRSTLY IDENTITY THE BASIS OF DECISION, I MEAN IDENTIFY THE LIMITED FACTOR OR KEY FACTOR, THEN CONSIDER THAT KEY FACTOR FOR BOTH THE PRODUCTS AND MAKE THE DECISION ON THE BASIS OF CONSIDERATION OF KEY FACTOR. b. CALCULATION OF NET INCOME PER UNIT IN THIS CASE AUTOMATIC MANUAL SALES 280 120 PRODUCTION COSTS: DIRECT MATERIAL 65 32 DIRECT LABOR 35 25 VARIABLE MANUFACTURING OVERHEAD 68 16 VARIABLE OPERATING EXPENSES 17 185 6 79 CONTRIBUTION MARGIN PER UNIT 95 41 FIXED MANUFACTURING OVERHEAD 50 18 NET INCOME PER UNIT (ONLY 6000 UNITS CAN BE SOLD) 45 23 MACHINE HOURS USED TO MAKE EACH PRODUCT 2.5 1 NET INCOME PER HOUR (KEY FACTOR ONLY 10000 MACHINE HRS ARE AVAILABLE) 18 23 OPTION 1: MAKE 6000 UNITS OF MANUAL HOUSEHOLD DEHUMIDIFIER USING 6000 HRS., 4000 HRS. SCRAPPED NET INCOME WILL INCREASE BY $ 23*6000=$138000 OPTION 2: MAKE 4000 UNITS OF AUTOMATIC HOUSEHOLD DEHUMIDIFIER USING 10000 HRS., NET INCOME WILL INCREASE BY $45*4000=$180000 OPTION 3: MAKE 6000 UNITS OF MANUAL HOUSEHOLD DEHUMIDIFIER USING 6000 HRS., 1600 UNITS OF AUTOMATIC HOUSEHOLD DEHUMIDIFIER USINF 4000 HRS., NET INCOME WILL INCREASE BY ($23*6000)+(1600*$45)=$210000 NET INCOME WILL BE HIGHER IN OPTION: 3 THEREFORE THAT SHOULD BE ADOPTED. MAKE 6000 UNITS OF MANUAL HOUSEHOLD DEHUMIDIFIER AND 1600 UNITS OF AUTOMATIC HOUSEHOLD DEHUMIDIFIER. c. CALCULATION OF NET INCOME PER UNIT IN THIS CASE AUTOMATIC MANUAL SALES 350 150 PRODUCTION COSTS: DIRECT MATERIAL 65 32 DIRECT LABOR 35 25 VARIABLE MANUFACTURING OVERHEAD 68 16 VARIABLE OPERATING EXPENSES 17 185 6 79 CONTRIBUTION MARGIN PER UNIT 165 71 FIXED MANUFACTURING OVERHEAD 50 18 NET INCOME PER UNIT BEFORE PROMOTION CAMPAIGN COSTING 115 53 MACHINE HOURS USED TO MAKE EACH PRODUCT 2.5 1 NET INCOME PER HOUR BEFORE PROMOTION CAMPAIGN COSTING (KEY FACTOR ONLY 10000 MACHINE HRS. ARE AVAILABLE) 46 53 HRS. UTILIZED EXCLUSIVELY ON EITHER PRODUCT 10000 10000 MAXIMUM UNITS CAN BE PRODUCED 4000 10000 TOTAL NET INCOME BEFORE PROMOTION CAMPAIGN COSTING 460000 530000 LESS: PROMOTION CAMPAIGN COSTING 225000 235000 NET INCOME 235000 295000 NET INCOME IN CASE OF MANUAL HOUSEHOLD DEHUMIDIFIER WILL BE HIGHER I.E. $ 295000, SO MAKE MANUAL HOUSEHOLD DEHUMIDIFIER. (IT IS SAID THAT PRODUCTION WILL BE EXCLUSIVELY OF EITHER PRODUCT, EITHER PRODUCT MEANS PRODUCTION CAN ONLY BE DONE ONLY ONE OF THE TWO PRODUCTS ON THE BASIS OF NET INCOME.

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