PRECISION ELECTRONICS
Mary White was a supervisor of an assembly department in Precision Electronics Company. In recent weeks, White had become convinced that a certain component Z-497, could be produced more efficiently if certain changes were made in assembly methods. White had described this proposal to the company's industrial engineer, but the engineer had quickly dismissed White's ideas-mainly, White thought, because the engineer had not thought of them first.
White had frequently thought of starting a business and felt that the ability to produce Z-497 component at a lower cost might provide this opportunity. Precision's purchasing agent assured White that Precision would be willing to buy Z-497s from White if the price were 10-15 percent below Precision's current cost of $2.97 per unit. Working at home, White experimented with the new methods, which were based on the use of a new fixture to aid in assembling each Z-497. This experimentation seemed successful, so White proceeded to prepare some estimates for large-scale Z-497 production.
White determined the following:
1. A local toolmaker would make the new fixtures for a price of $900 each. One fixture would be needed for each assembly worker.
2. Assembly workers were readily available, on either a full-time or part-time basis, at a wage of $6.75 per hour. White felt that another 20% of wages would be necessary for fringe benefits. White estimated that on the average (including rest breaks), a worker could assemble, test, and pack 15 units of the Z-497 per hour.
3. Purchased components for the Z-497 should cost about $1.53 per unit over the next year. Shipping supplies and delivery costs would amount to approximately $0.09 per unit.
4. Suitable space was available for assembly operations at a rental of $1,080 per month. A 12-month lease was required.
5. Assembly tables, stools, and other necessary equipment would cost about $540 per assembly worker.
6. White, as general manager, would receive a salary of $3,600 per month.
7. A combination office manager-book-keeper was available for a salary of $1,260 per month.
8. Miscellaneous costs, including maintenance supplies and utilities, were expected to average about $855 per month.
9. Precision Electronics would purchase between 400,000 and 525,000 units of Z-497 a year, with 450,000 being Precision's purchasing agent's "best guess." However, White would have to commit to a price of $2.52 per unit for the next 12 months.
White showed theses estimates to a friend who was a cost analyst in another electronics firm. This friend said that all of the estimates appeared reasonable, but told White that in addition to the required investment in fixtures and equipment, about $125,000 would be needed to finance accounts receivable and inventories. The friend also advised buying enough fixtures and other equipment to enable producing the maximum estimated volume (525,000 units per year) on a one-shift basis (assuming 2,000 labor-hours per assembler per year). White thought this was good advice.
Questions.
A. What are White's expected variable costs per unit? Fixed costs per month? What would the total costs per year of White's business be if volume were 400,000 units? 450,000 units? 525,000 units? (Limit yourself to cash costs; ignore depreciation of fixtures and equipment. Also, disregard any interest costs White might incur on borrowed funds.)
B. What is the average cost per unit of Z-497 at each of these three volumes?
C. Reanswer Questions A and B assuming that (1) White wanted to guarantee assembly workers 2,000 hours of pay per year; (2) enough workers would be hired to assemble 450,000 units a year; (3) these workers could work overtime at a cost (including fringes) of $12.15 per hour; and (4) no additional fixed costs would be incurred if overtime were needed. (Do not use these assumptions for Question D.)
D. Reanswer Questions A and B, now including depreciation cost. Assume the fixtures and other equipment have a useful life of six years, and that straight line depreciation will be used.
E. Do you think Mary White should resign from Precision Electronics and establish the proposed enterprise? Provide detailed reasoning for your answer.