HJM Auto Parts makes a muffler/pipe assembly for a cost of $45 each ($10 fixed a

Question

HJM Auto Parts makes a muffler/pipe assembly for a cost of $45 each ($10 fixed and $35 variable) and then sells it for $68. The opportunity exists to modify this assembly (to a more fuel-efficient model) for additional direct materials and labor cost totaling $5 per unit. The new muffler/pipe model is expected to sell for $80.00 each. Variable selling and distribution costs would be the same at $10 per unit. Projected sales volume is 60,000 units per year for the new model, the same level of sales as for the current assembly. Labor resources are very tight at present but machine capacity is underutilized.

Required:

1. Should HJM modify the existing assembly?
2. What would be the increase/decrease in profit if HJM modifies the assembly?

Explanation / Answer

1. It is given that labor resources are very tight but the machine capacity is underutilized. This implies that, to increase the revenue, the modification need to be taken. If the labor is available for modification, it is suggestible for the entity to modify the existing assembly as it would increase the revenue, utilize the un-utilized machine capacity.

2. The sales volume is not changed even though the modification is done. But the selling price has increased from $68 to $80, with an incremental sale price of $12 per unit. Their is increment in cost as well. An additional cost of $5 per unit for additional direct materials and labor. Net incremental revenue per unit is $7. Therefore, the increase in profit is $420,000 (60,000 units × $7).

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