Relevant costs for Business Decisions
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QUESTION #1
Chef-Mate is considering adding a gelato machine to its line of ice cream making machines and will negotiate its price through a Greek manufacturer. Management believes it can be sold for $5000 each, and annual sales will be 100 units, but Chef-Mate will have to invest $100,000 and variable cost of selling the machines would be $500 each.
Required:
1. If Chef-Mates requires 15% ROI, what is the maximum price the company would be willing to pay its Greek Manufacturer?
2. After many hours of negotiation, management concludes that the Greek manufacturer is not willing to sell at a price low enough for the company to earn its 15% ROI. Apart from abandoning the idea of adding the machine, what else can management do?
QUESTION #2
VOLUME TRADE-OFF DECISIONS: MANAGING THE CONSTRAINT
A company makes four soft drinks using sweetened concentrated flavored syrup in the company's bottling plant. The bottleneck in the production process is on the capping lineup, which is available for 2,500 hours per year. Data concerning the company's 4 main products are below, and products are sold in pallets:
Product A Product B Product C Product D
Gross revenue per pallet $856 $1,250 $659 $769
Contribution margin per pallet $356 $762 $444 $338
Annual Demand 85 105 95 135
Hours required in the kiln per pallet 9 9 5 4
No fixed costs could be avoided by modifying how much is produced of any product.
Required:
1. Is there sufficient capacity on the capping line-up to satisfy demand for all products?
2. What is the production plan for the year that would maximize the company's profit?
3. What would be the total contribution margin for the production plan you propose?
4. The bottling plant could be operated for more than 2,500 hours per year by running on overtime basis. Up to how much should the company pay in overtime wages and other expenses to operate the plant for additional hours?
5. If the company was to produce a new soft drink, with variable costs of $950 per stack, requiring 15 hours on the capping lineup, what is the minimal acceptable selling price for this new drink should be?
6. If salespersons are paid commission of 3% of gross revenues, would they be motivated to sell one product over another?
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The solution explains how to select the relevant costs for business decisions.
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QUESTION #1
Chef-Mate is considering adding a gelato machine to its line of ice cream making machines and will negotiate its price through a Greek manufacturer. Management believes it can be sold for $5000 each, and annual sales will be 100 units, but Chef-Mate will have to invest $100,000 and variable cost of selling the machines would be $500 each.
Required:
1. If Chef-Mates requires 15% ROI, what is the maximum price the company would be willing to pay its Greek Manufacturer?
We are given that 100 units would be sold at a price of $5,000 each and the variable cost is $500 each.
Net Income = Revenue - Expense
For 100 units, the revenue is 5,000X100=500,000 and the cost is 500X100=50,000
Net Income = 500,000-50,000=450,000
ROI = Net Income/Investment and we are given that ROI should be 15%
Investment = Net Income/ROI = 450,000/15% = $3,000,000
Total investment can be $3,000,000. Of this Chef-mate has to invest $100,000
The remaining amount would be the maximum investment for the machine
Maximum price = 3,000,000-100,000=$2,900,000
2. After many hours of negotiation, management concludes that the Greek manufacturer is not willing to sell at a price low enough for the company to earn its 15% ROI. Apart from abandoning the idea of adding the machine, what else can management do?
If the cost of the machine is not reduced. This implies that the investment is higher and so to generate 15% return, the net income has to be higher. The other options for Chef-mate are
1. Reduce the ...
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