Questions -
Q1. The management of Furman Industries has been evaluating whether the company should continue manufacturing a component or buy it from an outside supplier. A $100 cost per component was determined as follows:
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Direct material
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$ 15
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Direct labor
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40
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Variable manufacturing overhead
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10
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Fixed manufacturing overhead
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35
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$100
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Furman Industries uses 4,000 components per year. After Wilfert Corporation submitted a bid of $80 per component, some members of management felt they could reduce costs by buying from outside and discontinuing production of the component. If the component is obtained from Wilfert Corporation, Furman Industries' unused production facilities could be leased to another company for $50,000 per year.
Required:
a. Determine the maximum amount per unit Furman Industries could pay an outside supplier.
b. Indicate if the company should make or buy the component and the total dollar difference in favor of that alternative.
c. Assume the company could eliminate one production supervisor with a salary of $30,000 if the component is purchased from an outside supplier. Indicate if the company should make or buy the component and the total dollar difference in favor of that alternative.
Q2. Baxter Corporation is working at full production capacity producing 10,000 units of a unique product, JKL. Manufacturing costs per unit for JKL follow:
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Direct material
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$ 2
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Direct manufacturing labor
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3
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Manufacturing overhead
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5
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$10
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The unit manufacturing overhead cost is based on a variable cost per unit of $2 and fixed costs of $30,000 (at full capacity of 10,000 units). The non-manufacturing costs, all variable, are $4 per unit, and the selling price is $20 per unit. A customer, Jacksonville Company, has asked Baxter to produce 2,000 units of a modification of JKL to be called RST. RST would require the same manufacturing processes as JKL. Jacksonville Company has offered to share equally the non-manufacturing costs with Baxter. RST will sell at $15 per unit.
Required:
a. What is the opportunity cost to Baxter of producing the 2,000 units of RST (assume that no overtime is worked)?
b. The Graves Company has offered to produce 2,000 units of JKL for Brown, so Brown can accept the Jacksonville offer. Graves Company would charge Baxter $14 per unit for the JKL. Should Baxter accept the Graves Company offer?
c. Suppose Baxter had been working at less than full capacity producing 8,000 units of JKL at the time the RST offer was made. What is the minimum price Baxter should accept for RST under these conditions (ignoring the $15 price mentioned previously)?
Q3. The Davis Company normally produces 150,000 units of Product LM per year. Due to an economic downturn, the company has some idle capacity. Product LM sells for $15 per unit.
The firm's production, marketing, and administration costs at its normal capacity are:
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Per Unit
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Direct material
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$1.00
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Direct labor
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2.00
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Variable overhead
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1.50
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Fixed overhead
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($450,000/150,000 units)
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3.00
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Variable marketing costs
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1.05
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Fixed marketing and administrative costs
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($210,000/150,000 units)
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1.40
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Total
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$9.95
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Required:
a. Compute the firm's operating income before income taxes if the firm produced and sold 110,000 units.
b. For the current year, the firm expects to sell the same number of units as it sold in the prior year. However, in a trade newspaper, the firm noticed an invitation to bid on selling LM to a state government. There are no marketing costs associated with the order if Davis is awarded the contract. The company wishes to prepare a bid for 40,000 units at its full manufacturing cost plus $ 0.25 per unit. How much should it bid? If Davis is successful at getting the contract, what would be its effect on operating income?
c. Assume that the company is awarded the contract on January 2, and in addition it also receives an order from a foreign vendor for 40,000 units at the regular price of $15 per unit. The foreign shipment will require the firm to incur its normal marketing costs. The government contract contains a 10-day escape clause (i.e., the firm can reject the contract within 10 days without any penalty). If the firm accepts the government contract, overtime pay at 1 1/2 times the straight time rate will be paid on the 40,000 units. In addition, fixed overhead will increase by $60,000 and variable overhead will behave in its normal pattern. The company has the capacity to produce both orders. Decide the following:
1. Should the firm accept the foreign offer? Show the effect on operating income of accepting the order.
2. Assuming the foreign order is accepted, should the firm accept the government order? Show the effect on operating income of accepting the government order.
Q4. Bonds Corporation is interested in purchasing a state-of-the-art widget machine for its manufacturing plant. The new machine has been designed to basically eliminate all errors and defects in the widget-making production process. The new machine will cost $150,000, and have a salvage value of $70,000 at the end of its seven-year useful life. Bonds has determined that cash inflows for years 1 through 7 will be as follows: $32,000; $57,000; $15,000; $28,000; $16,000; $10,000, and $15,000, respectively. Maintenance will be required in years 3 and 6 at $10,000 and $7,000 respectively. Bonds uses a discount rate of 11 percent and wants projects to have a payback period of no longer than five years.
Present value tables or a financial calculator are required.
a. Compute the net present value of the new machine.
b. Compute the firm's profitability index.
c. Compute the payback period.
d. Evaluate this investment proposal for XYZ Co.
Q5. The Williams Company has been operating a small lunch counter for the convenience of employees. The counter occupies space that is not needed for any other business purpose. The lunch counter has been managed by a part-time employee whose annual salary is $3,000. Yearly operations have consistently shown a loss as follows:
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Receipts
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$20,000
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Expenses for food, supplies (in cash)
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$19,000
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Salary
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3,000
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22,000
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Net Loss
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$(2,000)
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A company has offered to sell Williams Company automatic vending machines for a total cost of $12,000. Sales terms are cash on delivery. The old equipment has zero disposal value.
The predicted useful life of the equipment is 10 years, with zero scrap value. The equipment will easily serve the same volume that the lunch counter handled. A catering company will completely service and supply the machines. Prices and variety of food and drink will be the same as those that prevailed at the lunch counter. The catering company will pay 5 percent of gross receipts to the Williams Company and will bear all costs of food, repairs, and so forth. The part-time employee will be discharged. Thus, Williams Company's only cost will be the initial outlay for the machines.
Consider only the two alternatives mentioned. Present value tables or a financial calculator are required.
Required:
a. What is the annual income difference between alternatives?
b. Compute the payback period.
c. Compute:
1. The net present value if relevant cost of capital is 20 percent.
2. Internal rate of return.
d. Management is very uncertain about the prospective revenue from the vending equipment. Suppose that the gross receipts amounted to $14,000 instead of $20,000. Repeat the computation in part c.1.
e. What would be the minimum amount of annual gross receipts from the vending equipment that would justify making the investment? Show computations.
Q6. The Cleanest Automobile Corporation is contemplating the acquisition of an automatic car wash. The following information is relevant:
The cost of the car wash is $160,000.
The anticipated revenue from the car wash is $100,000 per annum.
The useful life of the car wash is 10 years.
Annual operating costs are expected to be:
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Salaries
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$30,000
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Utilities
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9,600
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Water usage
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4,400
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Supplies
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6,000
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Repairs/maintenance
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10,000
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The firm uses straight-line depreciation.
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The salvage value for the car wash is zero.
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The company's cutoff points are as follows:
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Payback
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3 years
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Accounting rate of return
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18%
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Internal rate of return
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18%
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Ignore income taxes.
Required: Compute the annual cash inflow.