Question

SnapOn produces a variety of pharmaceuticals in large liquid batches. SnapOn business model to date has been to sell the drugs in liquid form to other companies that convert the liquid drug into dosage form for sale to consumers. SnapOn’s reputation for quality and service depends on its unsurpassed capability to handle liquids safely and with minimal waste. The company’s marginal tax rate is 30% and its weighted average cost of capital is 13.86%.

One of SnapOn’s processes involves consuming $50,000 of precursor chemicals, direct labor (variable), and variable overhead resources (such as electricity for heating and cooling) to produce a batch of 2,000 gallons of pain reliever PR1.

SnapOn currently packages PR1 into five-gallon plastic containers and ships them to Tablets Galore, a customer that buys about 20% of SnapOn total output each year. The plastic containers cost $2.10 each and SnapOn pays $0.50 per container for shipping. Tablets Galore pays $34 per gallon for PR1.

One of SnapOn’s managers, Anna R., has acquired access (with no investment required) to a tablet-making and packaging line. Anna estimates that SnapOn could produce eight cases of tablets from each gallon of PR1 and sell each case to distributors for $13.50 per case. Variable processing cost for tablet production would be $11.00 per gallon of PR1, while packaging will cost $5.16 per case. SnapOn will then pay $1.68 to ship each case to the distributor.

A.    What are the incremental revenues from selling PR1 as tablets?

B. What are the total incremental costs to convert one 2,000-gallon batch of PR1 to tablet form:

Resource	Process further	Sell as is	Difference
Liquid containers
Shipping
Processing
Packaging
		Total

C.    Calculate the incremental effect on profit per gallon of PR1

Incremental inflows per gallon of PR1
Incremental outflows per gallon PR1
Incremental pre-tax CF per gallon of PR1
Incremental after-tax CF per gal of PR1

D. Complete a comparison equation assuming 26,000 gallons of PR1 are involved each year and the demand for PR1 and associated products will last for four years. Put the appropriate symbol in the yellow cell and summarize your recommendations in the green box below.

(1) Net cash flow effect of processing PR1 into tablets	+	(2) Net qualitative effects of processing PR1 into tablets	?	(3) Reference Value
	+		?	$0

Explanation of D:

E. If the net qualitative value of processing further (qualitative benefits – qualitative costs) is ($800,000) for the next seven years, what is the minimum number of gallons of PR1 that must be involved to justify a decision to process PR1 further?

Answer 1

A . We will calcilate Incremental revenue from selling PR1 as tablets for a batch of 2000 gallon :-

Revenue from tablet if 2000 gallons of processed = 13.5x8x2000 = $216000

Revenue from sale of 2000 gallons of PR1 = 34x2000 =$68000.

Incremental revenue for the batch of 2000 gallons of PR1 if it is further processed into tablet = 216000-68000 = $148000

Also per gallon increase in revenue = 148000/2000 = $74 per gallon.

B. Total incremental cost to convert 1 batch of 2000 gallons PR1 to tablet form

Resource	process further	sell as is	difference
Liquid containers	0	840 [(2.10/5)x2000]	(840)
Shipping	26880 (1.68x8x2000)	200 [(0.5/5)x2000]	26680
Processing	22000 (11x2000)	0	22000
Packaging	82560 (5.16x8x2000)	0	82560
		Total	130400

This, incremental cost to further process 2000 gallons of PR1 into tablet =$130400.

C . Incremental effect on profit per gallon of of PR1

Incremental inflow per gallon of PR1	74
Incremental outflow per gallon of PR1 (130400/2000)	65.20
Incremental pre tax CF per gallon of PR1	8.80
Incremental after tax CF per gallon of PR1	6.16 (8.80x0.70)