Accounting and New Product Development - Math Problem Example

PART A Required COST IFICATION SHEET To access the cost ification sheet containing the costs in the Bill of Materials, Labor Routing, Manufacturing Overhead and Selling & General Administrative expenses identified as being Product or Period costs, Variable or Fixed Cost behaviors, Direct or Indirect costs of the vehicle production, click on the icon below: DISCRETIONARY COST The costs that are classified as discretionary are justified below: Advertising Expense: Advertising expense has been classified as discretionary cost as it is among the expenses that are fixed but can be altered in the short term by current management decisions. For example, the company can reduce its cost by spending less on advertising or going for a less expensive option in a budget year. Research and Development: This would be a discretionary cost for the company as the cost on research and development arises form management decision to spend a particular amount and management can reduce it in the short term if it is needed. Maintenance and Repair- Selling Expenses: This is another discretionary cost incurred by the company in selling the product. This can be reduced by management's decision in the short term to cut down the unnecessary maintenance and repairs. Maintenance and Repair- Administrative Expenses: The management can minimize this cost by delaying for short term, the unnecessary maintenance and repair expenses in the office. Reduction in these costs does not cause an irreparable loss to the company's operations. Required 2: ANNUAL VARIABLE COST PER UNIT Variable cost per unit = Direct material per unit + Direct labor per unit + Variable overhead per Unit + Variable selling and administrative expenses per unit = $4,468 + $1,503.5 + $1,403 + $1,396 = $8,770.5 per unit for the annual production expected TOTAL FIXED COST FOR THE YEAR Total fixed cost = Fixed overhead + Fixed selling and administrative expenses = $78,400,000 + $182,000,000 = $260,400,000 for the year Water Play Inc. INCOME STATEMENT* For the projected year Total Per Unit Sales $1,044,000,000 $14,500 Total variable expenses (631,476,000) (8,770.50) Contribution Margin $412,524,000 $5,729.50 Total Fixed Cost (260,400,000) (3,616.67) Operating Profit $152,124,000 $2,112.83 *COMPUTATIONS FOR INCOME STATEMENT Sales = Total sales units * Total per unit sale = 72000 * 14,500 = $1,044,000,000 Total Variable Expenses = Variable cost per unit * Total sales units = 8,770.5* 72000 = $631,476,000 BREAK EVEN ANALYSIS Number of Sales Units for Break Even: Break Even Sales Units = Fixed Cost Price - Variable Cost per unit = 260,400,000 5729.5 = 45,449 units. Sales Volume In Dollars for Break Even Total Sales = Total break even units * Total sales units = 45,449 * 14,500 = $659,010,500 Profit if the Sales is 6000 Units Per Month Sales per year = 6000*12 = 72000 units Profit per month = $152,124,000 Sales per month = 6000 units Profit per month = 152,124,000 / 12 = $12,677,000 Required 3: Based on the contribution income statement, the operating leverage ratio and margin of safety are calculated below: OPERATING LEVERAGE RATIO: The formula to compute the operating leverage ratio is: Operating Leverage = Contribution Margin/Net Income = $412,524,000/152,124,000 = 2.71 Operating leverage indicates what change in net income can be expected from a change in sales volume. An operating leverage of 2.7 implies that the change in net income will be 2.7 times as large as the change in sales volume. Therefore, for the projected profitability of Water Play Inc. that if sales increased by 10%, net income should increase by 27%. The net income of Water Play Inc. would be 2.7 times greater than its sales volume. MARGIN OF SAFETY: The margin of safety is measured in either dollars or units. It measures the potential effect of the risk that sales will fall short of planned levels. In terms of US $ Margin of safety in $ = expected sales- breakeven sales = 1,044,000,000 - 659,010,500 = $384,989,500 In terms of Units: Margin of safety in units = expected sales- breakeven sales = 72000- 45,449 = 26,551 units Margin of safety reveals the amount by which actual sales can drop before a firm will incur Loss. The larger the margin: the lesser the risk. (Sales can fall by a larger percentage before the company will show a loss.). The Margin of safety or Safety stock of Water Play Inc. is 26,551 units. It means that the company should maintain 26,551 units as safety stock in order to avoid the risk. Therefore, for the projected profitability of Water Play Inc., margin of safety shows that the company should maintain 26,551 units for sale as safety stock to keep a margin of safety. PART B: Required 1: For the calculation of the following: 1. Annual cash flows over the expected life of the equipment 2. Payback period 3. Annual rate of return 4. Net present value 5. Internal rate of return Please click on the icon below: Required 2: There are many points that should be considered before taking the make or buy decision, as it is one of the most critical supply chains, strategic decisions. The production department in the organization has a key role in this decision. The decision is important for a number of reasons. It determines and defines an organization's core competencies. It determines what level of investment the business should make internally as well as with suppliers. The production department in Keller Paints, Inc. has put forward a proposal of producing the paint cans instead of purchasing them. This proposal is based on the fact that the company wants to cut down its cost of production and has been looking for a feasible way to do it. Hence, it is important to measure the pros and cons of the project in terms of the cost of production that would be incurred in making the paint cans against its purchase cost that the company will have to bear, if it rejects the proposal. To reach to a decision as to should the equipment be purchased or produced by the company, we'll do the following analysis: Cost Of Producing Paint Cans Based on the information given, the following cost may be borne by the company in producing the paint cans: Cost of equipment $125,000/- Cost for training three employees 15,000/- Salary for three employees (2,000 * 9 * 3 * 5) 270,000/- Benefits (1800 * 3 + {20 % of 54,000}) 5 81,000/- Raw Material Costs (0.25 * 4,000,000) 1,000,000/- Variable Costs (0.05 * 4,000,000) 200,000/- Total Cost for paint cans 1,691,000/- Less: Residual Value (20,000) Total Effective Cost of paint cans $1,671,000/- Therefore, the company would incur a total cost of $1,671,000, if it decides to produce the paint cans. Now, we would see how much it would cost if it is to be purchased instead of being produced by the company: Purchase Cost Of Paint Cans Based on the information given, the following cost will be incurred by the company if it decides to purchase the paint cans: (0.45 * 4,000,000) $1,800,000/- So, now we can compare the total cost of the paint cans in both the cases and after comparing both the costs, we can analyze that, if the company decides to purchase the paint cans, it has to bear the excess cost of $1,800,000/-. Excess Payments (1,800,000 - 1,671,000) $129,000/- As the production has been investigating possible ways to cut down the total production costs, the proposal of making the paint cans instead of purchasing them can be profitable for the company based on the given information. Therefore, producing the paint cans is more feasible for the company than purchasing them and the company should accept the proposal put forward by the production department to trim the cost of production. Read More