Adapted trom ROBERT S KAPLAN INCOM Company The decline in our profits has become
ID: 2601363 • Letter: A
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Adapted trom ROBERT S KAPLAN INCOM Company The decline in our profits has become intolerable The severe price cuming in pumps has dropped ourpre-ta margin to less than 3%, far below our histoncal 10% margins. Fortunately, our competitors are overlooking the opportunities for profit inflow controllers. Our recent 10% price increase in that line has been implemented without losing any businets. Robert Johnson, president of the INCOM Company, was discussing operating results in the latest month with Ahmed Khan, his controller, and John Scott, his manufactring manager. The meeting among the three was taking place in an atmosphere tinged with apprehension because competitors had been reducing prices on pumps, INCOM's major product line. Since pumps were a commodity product, Johnson had seen no altemative but to match the reduced prices to maintain volume. But the price cuts had led to declining company profits, especially in the pump line (summary operating results for the previous month March 2016, are shown in Exhibits 1 and 2). INCOM supplied products to mamfacturers of water purification equipment. The company had started with a unique design for valves that it could produce to tolerances that were better than any in the incustry Johnson quickly established a loyal customer base because of the high quality of its manufactured valves. He and Scott realized that INCOM's existing labor skills and machining equipment could also be used to produce pumps and flow controllers, products that were also purchased by its customers. They soon established a major presence in the high-volume pump product line and the more customized flow controller line. INCOMs production process started with the purchase of semi-finished components from several suppliers. It machined these parts to the required tolerances and assembled them in the company's modern manufacturing facility. The same equipment and labor were used for all three product Lines, and production rms were scheduled to match customer shipping requirements. Suppliers and customers had agreed to just-in-time deliveries, and products were packed and shipped as completed. Valves were produced by assembling four different machined components (2 components of L12 and 2 of L15). Scott had designed machines that held components in fixtures so that they could be machined automatically. The valves were standard products and could be produced and shipped in large lots. Although Scott felt several competitors could now match Johnson's quality in valves, none had tried to gain market share by cutting price, and gross margins had been maintained at a standard 35%. The manufacturing process for pumps was practically identical to that for valves. Five components G components of L12 and 2 of L14) were machined and then assembled into the final product. The pumps were shipped to inchustrial product distibutors after assembly. Recently, it seemed as if each month brought new reports of reduced pnces for pumps. INCOM had matched the lower prices so that it would not give up its place as a major pump supplier. Gross margins on pump sales in the latest month had fallen below 20%, well below the company's planned gross margin of 35%. Flow controllers were devices that controlled the rate and direction of flow of chemicals. They required more components and more labor, than pumps or valves, for each finished unit. Each Flow controller required 4 components of L16, 5 components of L12 and 1 component of L21. Also, there was much more variety in the types of flow controllers used in industry, so many more production runs and shipments were performed for this product line than for valves. NCOM had recently raised flow controller prices by more than 10% with no apparent effect on demand.Explanation / Answer
1. Income statement (assuming prices of raw material will increase by 5%)
Sales
$ 2,195,550
100%
Direct labour expenses
$ 271,250
Direct material expenses
$ 480,900
Manufacturing overhead
Machine related expenses
$ 336,000
Setup labour
$ 40,000
Receiving and production control
$ 180,000
Engineering
$ 100,000
Packaging and shipping
$ 150,000
Total manufacting overhead
$ 806,000
Gross Margin
$ 637,400
29%
General, selling and Admin expenses
$ 559,650
Operating income (pretax)
$ 77,750
4%
The company should increase the selling price by 2% to keep their margin.
2. Contribution Margin Income statement for March 2016
Sales
$ 2,152,500
Direct Labour expenses
$ 271,250
Direct material expenses
$ 458,000
Variable manufacturing overheads
Machine related expenses
$ 268,800
Receiving and production control
$ 162,000
Packaging and shipping
$ 75,000
General, selling and Admin expenses
$ 55,965
Total Variable overheads
$ 561,765
Contribution Margin
$ 861,485
Fixed Manufacturing overheads
Machine related expenses
$ 67,200
Setup labour
$ 40,000
Receiving and production control
$ 18,000
Engineering
$ 100,000
Packaging and shipping
$ 75,000
General, selling and Admin expenses
$ 503,685
Total Fixed overheads
$ 803,885
Operating Income (pre tax)
$ 57,600
3. INCOM Income statement for the month of April, 2016
Sales
$ 2,138,600
Direct labour expenses
$ 268,000
Direct material expenses
$ 454,000
Manufacturing Overhead
Machine related expenses
$ 331,800
Setup labour
$ 40,000
Receiving and production control
$ 180,000
Engineering
$ 100,000
Packaging and shipping
$ 150,000
Total manufacting overheads
$ 801,800
Gross Margin
$ 614,800
General, selling and Admin expenses
$ 559,650
Operating income (pretax)
$ 55,150
Working note
Valves
Pumps
Flow Controllers
Total
Production
7600
12000
4200
23800
Selling price per unit
$86
$87
$105
Sales
$ 653,600
$ 1,044,000
$ 441,000
$ 2,138,600
Direct labour expeses
$ 76,000
$ 150,000
$ 42,000
$ 268,000
Direct Material expenses
$ 121,600
$ 240,000
$ 92,400
$ 454,000
Machine hours per unit
0.5
0.5
0.3
Machine hours
3800
6000
1260
11060
It is assumed that production runs, number of shipment and hours of engineering work are similar to March 2016
4. Break even poiint
Break even point = Fixed costs/contribution margin per unit
= 803885/35.90
=22392 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7150
11290
3952
22392
Selling price per unit
86
87
105
Break even point in Dollars
$ 614,933
$ 982,237
$ 414,911
$ 2,012,081
Contribution margin per unit = $861485/24000 units
= 35.90
5. Break even point assuming an increase of 5% in direct material cost
Contribution margin per unit = $838585/24000 units
= $35
Break even point = 803885/35
= 22968 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7334
11581
4053
22968
Selling price per unit
86
87
105
Break even point in Dollars
$ 630,751
$ 1,007,504
$ 425,584
$ 2,063,839
6. Break even point assuming 5% increase in material cost and general, selling and admin expenses
Fixed cost = $803885+$25184
= $829069
Contribution margin per unit = $835787/24000 units
= 34.83 per unit
Break even point = 829069/34.83
= 23803 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7601
12002
4201
23803
Selling price per unit
86
87
105
Break even point in Dollars
$ 653,682
$ 1,044,132
$ 441,056
$ 2,138,870
7. Product price change to increase its Net operating income margin to 8.5%
Valves
Pumps
Flow Controllers
Total
Production
7600
12000
4200
23800
Selling price per unit
$95
$87
$122
Sales
$ 723,140
$ 1,044,000
$ 510,510
$ 2,277,650
1. Income statement (assuming prices of raw material will increase by 5%)
Sales
$ 2,195,550
100%
Direct labour expenses
$ 271,250
Direct material expenses
$ 480,900
Manufacturing overhead
Machine related expenses
$ 336,000
Setup labour
$ 40,000
Receiving and production control
$ 180,000
Engineering
$ 100,000
Packaging and shipping
$ 150,000
Total manufacting overhead
$ 806,000
Gross Margin
$ 637,400
29%
General, selling and Admin expenses
$ 559,650
Operating income (pretax)
$ 77,750
4%
The company should increase the selling price by 2% to keep their margin.
2. Contribution Margin Income statement for March 2016
Sales
$ 2,152,500
Direct Labour expenses
$ 271,250
Direct material expenses
$ 458,000
Variable manufacturing overheads
Machine related expenses
$ 268,800
Receiving and production control
$ 162,000
Packaging and shipping
$ 75,000
General, selling and Admin expenses
$ 55,965
Total Variable overheads
$ 561,765
Contribution Margin
$ 861,485
Fixed Manufacturing overheads
Machine related expenses
$ 67,200
Setup labour
$ 40,000
Receiving and production control
$ 18,000
Engineering
$ 100,000
Packaging and shipping
$ 75,000
General, selling and Admin expenses
$ 503,685
Total Fixed overheads
$ 803,885
Operating Income (pre tax)
$ 57,600
3. INCOM Income statement for the month of April, 2016
Sales
$ 2,138,600
Direct labour expenses
$ 268,000
Direct material expenses
$ 454,000
Manufacturing Overhead
Machine related expenses
$ 331,800
Setup labour
$ 40,000
Receiving and production control
$ 180,000
Engineering
$ 100,000
Packaging and shipping
$ 150,000
Total manufacting overheads
$ 801,800
Gross Margin
$ 614,800
General, selling and Admin expenses
$ 559,650
Operating income (pretax)
$ 55,150
Working note
Valves
Pumps
Flow Controllers
Total
Production
7600
12000
4200
23800
Selling price per unit
$86
$87
$105
Sales
$ 653,600
$ 1,044,000
$ 441,000
$ 2,138,600
Direct labour expeses
$ 76,000
$ 150,000
$ 42,000
$ 268,000
Direct Material expenses
$ 121,600
$ 240,000
$ 92,400
$ 454,000
Machine hours per unit
0.5
0.5
0.3
Machine hours
3800
6000
1260
11060
It is assumed that production runs, number of shipment and hours of engineering work are similar to March 2016
4. Break even poiint
Break even point = Fixed costs/contribution margin per unit
= 803885/35.90
=22392 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7150
11290
3952
22392
Selling price per unit
86
87
105
Break even point in Dollars
$ 614,933
$ 982,237
$ 414,911
$ 2,012,081
Contribution margin per unit = $861485/24000 units
= 35.90
5. Break even point assuming an increase of 5% in direct material cost
Contribution margin per unit = $838585/24000 units
= $35
Break even point = 803885/35
= 22968 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7334
11581
4053
22968
Selling price per unit
86
87
105
Break even point in Dollars
$ 630,751
$ 1,007,504
$ 425,584
$ 2,063,839
6. Break even point assuming 5% increase in material cost and general, selling and admin expenses
Fixed cost = $803885+$25184
= $829069
Contribution margin per unit = $835787/24000 units
= 34.83 per unit
Break even point = 829069/34.83
= 23803 units
Break even point in sales
Valves
Pumps
Flow Controllers
Units
7601
12002
4201
23803
Selling price per unit
86
87
105
Break even point in Dollars
$ 653,682
$ 1,044,132
$ 441,056
$ 2,138,870
7. Product price change to increase its Net operating income margin to 8.5%
Valves
Pumps
Flow Controllers
Total
Production
7600
12000
4200
23800
Selling price per unit
$95
$87
$122
Sales
$ 723,140
$ 1,044,000
$ 510,510
$ 2,277,650
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