1. Sealing Company manufactures three types of floppy disk storage units. Each of the three types requires the use of a special machine that has a total operating capacity of 15,000 hours per year. Information on the three types of storage units is as follows: Basic Standard Deluxe Selling price $9.00 $30.00 $35.00 Variable cost $6.00 $20.00 $10.00 Machine hours required 0.10 0.50 0.75 Question: 1. How many of each type of unit should be produced and sold to maximize the company's contribution margin? What is the total contribution margin for your selection? 2. Now, suppose that Sealing Company believes that it can sell no more than 12,000 of the deluxe model but up to 50,000 each of the basic and standard models at the selling prices estimated. What product mix would you recommend, and what would the total contribution margin be? 2. Steve Mumingham, manager of an electronics division, was considering an offer by Pat Sellers, manager of a sister division.. Pat's division was operating below capacity and had just been given an opportunity to produce 8,000 units of one of its products for a customer in a market not normally served. The opportunity involves a product that uses an electrical component produced by Steve's division. Each unit that Pat's department produces requires two of the components. However, the price the customer is willing to pay is well below the price usually charged; to make a reasonable profit on the order, Pat needs a price concession from Steve's division. Pat had offered to pay full manufacturing cost for the parts. So that Steve would know that everything was aboveboard, Pat had supplied the following unit-cost and price information concerning the special order, excluding the cost of the electrical components: Selling price $32 Less costs: Direct materials (17) Direct labor (7) Variable overhead (2) Fixed overhead . (3) Operating profit = $3 The normal selling price of the electrical component is $2.30 per unit. Its full manufacturing cost is $1.85 ($1.05 variable and $0.80 fixed). Pat had argued that paying $2.30 per component would wipe out the operating profit and result in her division showing a loss. Steve was interested in the offer because his division was also operating below capacity (the order would not use all the excess capacity). Question: 1. Should Steve accept the order at a selling price of $1.85 per unit? By how much will his division's profits be changed if the order is accepted? By how much will the profits of Pat's division change if Steve agrees to supply the part at full cost? 2. Suppose that Steve offers to supply the component at $2. In offering the price. Steve says that it is a firm offer is not subject to negotiation. Should Pat accept the price and produce the special? If Pat accepts the price, what is the change in profits for Steve's division? 3. Assume that Steve's division is operating at full capacity and that Steve refuses to supply the part for less than the full price. Should Pat still accept the special order? Explain. 3. Dr. Whitley Avard, plastic surgeon, had just returned from a conference in which he learned of a new surgical procedure for removing wrinkles around eyes in half of the usual time. Given her patient-load pressures, Dr. Avard was anxious to try out trying new technique. By decreasing the time spent on eye treatments or procedures, she could perform more services within a work period and thus increase her total revenues. Unfortunately, in order to implement the new procedure, some special equipment costing $74,000 was needed. The equipment had an expected life of four years, with a salvage value of $6,000. Dr. Avard estimate that her cash revenues would increase by the following amounts: Year Revenue Increases 1 $19,800 2 27,000 3 32,400 4 32,400 She also expected addtional expenses amounting to $3,000 per year. The cost of capital is 12 percent. Assume there are no income taxes. Questions: 1. Compute the payback period for the new equipment. 2. Compute the accounting rate of return using both original investment and average investment. 3. Compute the NPV and IRR for the project. Should Dr. Avard purchase the new equipment? Should she be concerned about payback or the accounting rate of return in making this decision? 4. Before finalizing her decision, Dr. Avard decided to call two plastic surgeons that had been using the new procedure for the past six months. The conversations revealed a somewhat less glowing report than she had received at the Conference. The new procedure reduced the time required by about 25 percent rather than the advertised 50 percent. Dr. Avard estimated that the net operating cash flows of the procedure would be cut by one-third because of the extra time and cost involved (salvage value would be unaffected). Using this information, recomputed the NPV of the project. What would you now recommend? 4. Madison Company is considering replacing its existing mainframe computer, new model manufactured by a different company. The existing computer was at least three years ago, has a remaining life of five years, and will have a salvage value $10,000. The book value is $200,000. Straight-line depreciation with a half- life convention is being used for tax purposes. The computer's cash operating costs, including software, personnel, and other supplies, total $100,000 per year. The new computer has an initial cost of $500,000 and will have cash operating cost of $50,000 per year. The new computer will have a life of five years and salvage value of $100,000 at the end of the fifth year. MACRS depreciation will be used for tax purposes. If the new computer is purchased, the old one will be sold for $50,000. The company needs to decide whether to keep the old computer or buy the new one. The cost of capital is 12 percent. The tax rate is 40 percent. Question: Compute the NPV of each alternative. Should the company keep the old computer or buy the new one? 5. Geneva Company produces safety goggles for coal-miners. Goggles are produced in batches according to model and size. Although the setup and production time varies for each model, the smallest lead- time is six days. The most popular model, Model SG4, takes two days for setup, and the production rate is 750 units per day. The expected annual demand for the model is 36,000 units. Demand for the model however, can reach 45,000 units. The cost of carrying one SG4 unit is $3 per unit The setup cost is $6,000. Geneva chooses its batch size based on the economic order quantity criterion. Expected annual demand is used to compute the EOQ. Recently, Geneva has encountered some stiff competition-especially from foreign sources. Some of the foreign competitors have been able to produce and deliver goggles to retailers in half the time it takes Geneva to produce. For example, a retailer recently requested a delivery of 12,000 Models SG4 goggles with the stipulation that they be delivered within seven working days. Geneva had 3,000 units of SG4 in stock. It informed the potential customer that it could deliver 3,000 immediately and the other 9,000 units in about 14 working days-with the possibility of interim partial orders being delivered. The customer declined the offer stating that the total order had to be delivered within seven working days so that its stores could take advantage of some special conditions. The customer expressed and indicated that it would accept the order from another competitor who could satisfy the time requirements. Questions 1. Calculate the optimal batch size for Model SG4 using the EOQ model. Was Geneva's response to the customer right? Would it take the time indicated to produce the number of units wanted by the customer? Explain with Supporting computations. 2. Upon learning of the lost order, the marketing manager grumbled about Geneva’s inventory policy. "We lost the order because we didn't have sufficient inventory. We need to carry more units in inventory to deal with unexpected orders like these. Do you agree? How much additional inventory would have been needed to meet the customer inventory requirements? In the future, should Geneva carry more inventory? Can you think of other solutions? 3. Fenton Gray, the head of industrial engineering, reacted differently to the order. "Our problem is more complex than insufficient inventory. I know our foreign competitors carry much less inventory than we do. What we need to do is decrease the lead- time. I have been studying this problem, and my staff has found a way to reduce setup time for Model SG4 from two days to 1.5 by Using this new procedure, setup cost can be reduced to about $94. Also, by managing the plant layout for this product-creating what are called managing cells-we can increase the production rate from 750 units per day to about 2,000 units per day. This is done simply by eliminating a lot of move time waiting time-both non-value-added activities. Assume that the engineer's estimates are on target. Compute the new optimal batch size (using the EOQ formula). What is the new lead- time? Given this new information, would Geneva have been able to meet the customer's time requirements? Assume that there are eight hours available in each workday' 4. Suppose that the setup time and cost are reduced to 0.5 hours and $10, respectively. What is the batch size now? As setup time approaches zero and the cost becomes negligible, what does this imply? Assume for example that it takes five minutes to set up and costs about $0.864 per setup. 6. Curtis Remedies, Inc., produces two herbal mixes: Immune Boost and Menta Growth Immune Boost has more ingredients and requires more machine time for grinding and mixing. The manufacturing process is highly mechanized; both products are produced by the same equipment by using different settings. For the coming period 640,000 machine hours are available. Management is trying to decide on the quantities of each product to produce (in bottles of 30 pills). The following data are available ImmuneBoost MentaGrowth Machine hours per unit 1.60 0.80 Unit selling price 4.00 4.80 Unit variable cost 2.40 3.60 Question 1. Determine the units of each product that should be produced in order to maximize profits. What is the total contribution margin earned by this optimal mix? 2. Because of market conditions, the company can sell no more than 400,000 bottles of Immune Boost and 480,000 bottles of Menta Growth. Now, what is the optimal mix? Total contribution margin?
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