Question

Moveover Motors Ltd (MML), located in Melbourne, produces and sells a medium-sized family car called the Moveover Magnet. The company has been producing cars for the Australian market for over 30 years and began exporting a limited number of cars to the United States about 10 years ago. MML is a subsidiary of a Polish multinational that has not been satisfied with the losses that the company has been making in the last few years. The parent company in Poland is threatening to close the Australian factory unless MML can produce a profit in the next year of operations. The factory currently has a capacity to produce 50,000 cars per year but all realistic estimates of its market size, including the exports to the United States, suggest that it will not sell more than 30,000 cars per year in any of the next 5 years.

Jane Woodall, MML’s CEO, was very concerned about MML’s poor profitability. She asked Lester Bush, financial controller and Max Lemond, production manager, to see if there were ways to reduce costs and improve profitability.

Lester analysed the cost structure of MML and found the following:Variable cost- $15,000 per car

Fixed cost- $450,000,000 for 30,000 cars, or $15,000 per car

Selling and administrative expenses: Variable cost- $5,000 per car

Fixed cost- $180,000,000
During the year end 30 June 2017, MML sold 28,000 Moveover Magnets for $40,000 each.

Lester considered the fact that the capacity of the factory significantly exceeds the production levels and realised that significant savings could be made in both the production and administrative fixed expenses if some of the factory were disposed of. He estimated that by reducing the capacity to 30,000 cars per year, the fixed manufacturing costs would fall to $300 million and the fixed administrative costs would decrease to $160 million.

Before Lester could report back to Jane, Max returned with a proposal to reduce the variable costs to 30% of revenues by reducing the costs MML incurred for safe disposal of wasted metals. Lester was concerned that this would expose the company to potential environmental liabilities and he let Max know it.

3

Case Study

Case Study Presentation (10%)

Lester: Max, we would need to estimate the potential environmental costs and include them in your Analysis.

Max: You can’t do that. We are not violating any laws. There is some possibility that we may have to incur environmental costs in the future, but if we bring it up now, this proposal will not go through because our senior management always assumes these costs to be larger than they turn out to be. The market is tough, and we are in danger of shutting down the company. I don’t want all my colleagues to lose their jobs. The only reason our competitors are making money is because they are doing exactly what I am proposing...

Make recommendations for improving the profitability of Moveover Magnets.

Answer 1

Maximum Capacity(no.of cars)	50000		30000			50000
			Lester's plan				Max's plan
Col.	1		2	3		4	5	6
Sales units	28000		28000	30000		28000	30000	50000
Selling price	40000		40000	40000		40000	40000	40000
Less:
Variable cost/Car	15000		15000	15000		12000	12000	12000
Gross contribution	25000		25000	25000		28000	28000	28000
Less: Variable S& A	5000		5000	5000		5000	5000	5000
Net contribution/car	20000		20000	20000		23000	23000	23000
Total contn.(net contn.*No.of cars)	560000000		560000000	600000000		644000000	690000000	1150000000
Less: Fixed costs:
Mfg.	450000000		300000000	300000000		450000000	450000000	450000000
S&A	180000000		160000000	160000000		180000000	180000000	180000000
Total fixed costs	630000000		460000000	460000000		630000000	630000000	630000000
Net income	-70000000		100000000	140000000		14000000	60000000	520000000

From the above, Lester's plan seems to be a better option--for the following reasons:

reduce huge amounts of fixed costs(to the tune of 170 mlns.)& also increase cash flow within the company (savings in costs as well as disposal proceeds)-

makes profit even under the current level of sales units of 28000 cars per year .(col.2)

can make profit to the tune of 140 mlns. Under maximum capacity of 30000 cars.(col.3)

Also MML is not likely to sell more than 30000 cars(its own realistic estimate), in the next 5 years, excess capacity can be dispensed with.

More profitable than Max's options(col.4&5 )----selling maximum of 50000 cars (as per Col.6) is not envisioned

Max's plan is certain to pave the way for de-licensing of the entire unit--as environmental laws & fines for their violations are really stringent & not worth taking the risk .

Recommendation:

Since,the parent company in Poland is threatening to close the Australian factory unless MML can produce a profit in the next year of operations, the immediate course of action will be to go with Lester's plans.