Problem -
Cincinnati Flow Technology (CFT) has purchased 10,000 pumps annually from Kobec, Inc. Because the price keeps increasing and reached $102.00 per unit last year, CFT's management has asked for an estimate of the cost of manufacturing the pump in CFT's facilities. CFT makes stampings and castings and has little experience with products requiring assembly. The engineering, manufacturing, and accounting departments have prepared a report for management which includes the following estimate for an assembly run of 10,000 pumps. Additional production employees would be hired to manufacture the pumps but no additional equipment, space, or supervision would be needed. The report states that total costs for 10,000 units are estimated at $1,435,500 or $143.55 per unit. The current purchase price is $102.00 per unit, so the report recommends continued purchase of the product.
Components (outside purchases) - $ 180,000
Assembly labor* - 450,000
Manufacturing overhead† - 675,000
General and administrative overhead‡ - 130,500
Total costs - $1,435,500
*Assembly labor consists of hourly production workers.
†Manufacturing overhead is applied to products on a direct-labor-dollar basis. Variable-overhead costs vary closely with direct-labor dollars.
Fixed overhead - 50% of direct-labor dollars
Variable overhead - 100% of direct-labor dollars
Manufacturing-overhead rate - 150% of direct-labor dollars
‡General and administrative overhead is applied at 10 percent of the total cost of material (or components), assembly labor, and manufacturing overhead.
Required: Were the analysis prepared by Cincinnati Flow Technology's engineering, manufacturing, and accounting departments and their recommendation to continue purchasing the pumps correct? Explain your answer and include any supporting calculations you consider necessary.
Martinez, Inc., is a small firm involved in the production and sale of electronic business products. The company is well known for its attention to quality and innovation.
During the past 15 months, a new product has been under development that allows users hand-held access to e-mail and video images. Martinez named the product the Wireless Wizard and has been quietly designing two models: Standard and Enhanced. Development costs have amounted to $181,500 and $262,500, respectively. The total market demand for each model is expected to be 40,000 units, and management anticipates being able to obtain the following market shares: Standard, 25 percent; Enhanced, 20 percent. Forecasted data follow. Standard Enhanced
Projected selling price $375.00 $495.00
Production costs per unit: Direct material 42.00 67.50
Direct labor 22.50 30.00
Variable overhead 36.00 48.00
Marketing and advertising per product line 195,000 300,000
Sales salaries per product line 85,500 85,500
Sales commissions* 10% 10%
*Computed on the basis of sales dollars.
Since the start of development work on the Wireless Wizard, advances in technology have altered the market somewhat, and management now believes that the company can introduce only one of the two models. Consultants confirmed this fact not too long ago, with Martinez paying $34,500 for an in-depth market study. The total fixed overhead is expected to be the same regardless of which product is manufactured.
Required:
1. Compute the per-unit contribution margin for both models.
2. Which of the data above should be ignored in making the product-introduction decision? For what reason?
3. Prepare a financial analysis and determine which of the two models should be introduced.
4. What other factors should Martinez consider before a final decision is made?