Part 1:
Off Road, Inc. (ORI) is considering a new product-a shock absorbing seat cushion to be sold to its Dune Buggy customers. Currently, ORI does not sell any accessories, so this product will not affect the sales or costs of any other product.
The seat cushion is expected to sell for $60 per unit. Variable production cost is estimated at $7 per unit, packaging at $2 per unit, and other variable costs at $1 per unit. Fixed costs, above those already incurred by the company, expected to result from this product are estimated at $1,000 annually. In addition, the product will tie up an average of $5,000 in working capital, which will not be freed up until termination of the product.
ORI feels it can add the product cheaply because it has excess capacity in its administrative functions. For example, preparation of orders, billing, and shipping of the seat cushions can be handled by the current staff. In addition, production and storage will use a small currently idle portion of the existing plant and warehouse. Under the current cost allocation system, the existing overhead that could be allocated to the new product totals $4,000 annually.
ORI is in the 30% income tax bracket and uses the same accounting policies and procedures for income tax reporting as it does for financial reporting.
ORI's weighted average cost of capital is 13%. Its average borrowing rate is 12%; its borrowing rate on its most recent loan is 14%; and its incremental borrowing rate for it next loan is 15%. No new borrowing is expected to result from addition of this product.
Requirement: You will work in your normal team. Management has asked you to determine the level of annual sales necessary for this product to "break even." Management is aware that there is infrequently "one right answer"; therefore, management wants you to provide three alternative computations in rank order from best to third best and provide brief explanations of the strengths and weaknesses of each "solution" along with the computation.
Part 2:
Off Road, Inc. (ORI) sells a dune buggy accessory: a gun rack for the roll bar. Actual 2002 and estimated/projected 2003 cost information for the accessory are presented below.
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Estimated
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Actual
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|
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2003
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2002
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|
Sales*
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100,000
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89,985
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Cost of goods sold**
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|
|
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Direct materials
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22,000
|
17,140
|
|
Direct labor
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5,000
|
4,200
|
|
Variable manufacturing overhead
|
6,000
|
5,185
|
|
Fixed manufacturing overhead
|
11,000
|
13,475
|
|
Gross profit
|
56,000
|
49,985
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|
Selling Expenses:
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|
|
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Sales salaries
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12,000
|
11,500
|
|
Sales commissions
|
5,000
|
4,500
|
|
Depreciation, sales equipment
|
2,000
|
2,000
|
|
Administrative expenses:
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|
|
|
Office salaries
|
12,000
|
11,200
|
|
Depreciation, office equipment
|
1,600
|
1,400
|
|
Rent
|
5,000
|
4,500
|
|
Insurance
|
1,400
|
1,100
|
|
Operating Income
|
17,000
|
13,785
|
*Sales are based on a selling price of $105 per unit in 2002 and, due to competition, $100 per unit in 2003.
**Units produced = units sold
Requirement: You will work in your normal team. Management has asked you to determine the level of sales necessary for this product to "break even" in 2003.