Question 2: Pricing & possible plant closure
Handy Household Products Ltd is a multiproduct company with several manufacturing plants. The Fremantle plant manufactures and distributes two household cleaning and polishing compounds, standard and commercial, under the Clean & Bright label. The forecast operating results for the first six months of the current year, when 100000 boxes of each compound are expected to be manufactured and sold, are presented in the following statement:
Clean&Bright Compounds, Fremantle plant Forecast results of operations for the six-month period ending June 30(in 000s)
Sales
Cost of goods sold
Gross profit
Selling and administrative expenses: Variable
Fixed*
Total selling and administrative expenses Profit (loss) before taxes
Standard
$2000
1600 $ 400
$ 400 240 $ 640
$ (240)
Commercial
$3000
1900 $1100
$ 700
$1060 $= 4 0
Total
$5000
3500 $1500
$1100
§QQ
$1700 $(200)
*The fixed selling and administrative expenses are allocated between the two products on the basis of dollar sales volume.
The standard compound sold for $20 a box and the commercial compound sold for $30 a box during the first six months of the year. The manufacturing costs are presented in the schedule below. Each product is manufactured on a separate production line. Annual normal manufacturing capacity is 200 000 boxes of each product. However. the plant is capable of producing 250 000 boxes of standard compound and 350000 boxes of commercial compound annually.
Direct material
Direct labour
Variable manufacturing overhead
Fixed manufacturing overhead
Total manufacturing cost
Variable selling and administrative costs
Cost perbox
Standard Commercial
$7.00 $8.00 4.00 4.00 1.00 2.00 4.00 5.00 $16.00 $19.00 $4.00 $7.00
The following schedule reflects the consensus of top management regarding the price-volume alternatives for the Clean & Bright products for the last six months of the current year. These are essentially the same alternatives management had during the first six months of the year.
Alternative prices (per box)
$18 20 21 22 23
Sales volume (in boxes)
Alternative prices (per box)
Sales volume (in boxes)
175000 140000 100000
55000 35000
Standard compound
Commercialcompound
120000 $25 100000 27 90000 30 80000 32 50000 35
4
Handy Household Products' top management believe that the loss for the first six months reflects a tight profit margin caused by intense competition. Management also believe that many companies will leave this market by next year and profit should improve.
Required:
What unit selling price should management select for each of the Clean & Bright compounds for the remaining six months of the year to maximise profit? Support your selection with appropriate calculations.
Independently of your answer to requirement 1, assume that the optimum alternatives for the last six months were as follows: a selling price of $23 and volume of 50 000 boxes for the standard compound, and a selling price of $35 and volume of 35 000 boxes for the commercial compound.
(a) Should management consider closing down the plant's operations until January 1 of the next year in order to minimise its losses? Support your answer with appropriate calculations.
(b) Identify and discuss the strategic factors that should be considered in deciding whether the Fremantle plant should be closed down during the last six months of the current year.