Question

A while later Manny comes into your office with another proposal that came past his desk. As part of GT’s mining operations, GT produces its own mine excavator tracks. A Japanese consortium, KoBI Engineering, has approached GT to produce the excavator tracks for GT.

You pull out your general ledger report, and you review the expenses for tracks last year. GT will typically produce its 90 excavator tracks, with a cost to the end of last year as follows:

Direct Materials: $175,000

Labour for employees working directly on the tracks: $300,000

Overhead for Factory workshop:

Annual Rent: $100,000

Annual Depreciation on factory machinery: $12,000

Factory Machine parts: $50,000

Factory Utilities: $30,000

Kobi has offered to sell GT the excavator tracks at $6,100/ unit.

The workshop is used for a number of functions outside of the manufacturing of tracks.

Requirement:

Undertake an analysis of the above costs and advise Manny on which option should be taken from a purely financial perspective

Question 2(b):

GT has three products that it sells: Copper, Bauxite, and Gravel. Results of the fourth quarter are presented below:

Copper Bauxite Gravel Total

Tonnage Sold 10,000 20,000 20,000

Revenue $22,000,000 $40,000,000 $23,000,000 $85,000,000

Variable costs 17,000,000 22,000,000 12,000,000 51,000,000

Direct fixed costs 1,000,000 3,000,000 2,000,000 6,000,000

Allocated fixed costs 8,000,000 8,000,000 8,000,000 24,000,000

Net income (loss) $ (4,000,000) $ 7,000,000 $ 1,000,000 $ 4,000,000

The allocated fixed costs are unavoidable. Demand of individual products is not affected by changes in other product lines.

Requirement

Do a financial analysis of what will happen to profits if GT sells the copper division?

Question 2(c):

Use the financial information provided to you in part 2(b). Please do a break-even analysis on each product to confirm the level of production needed for each product line.

Answer 1

Answer to 2(a):
Make or Buy Decision
Calculation of Cost of Manufacturing Excavator
Particulars	Amount
Direct Materials	$1,75,000
Labour	$3,00,000
Overheads:
Annual Rent	$1,00,000
Annual Depreciation	$12,000
Factory Machine Parts	$50,000
Factory Utilities	$30,000
Cost of Manufacturing Excavators	$6,67,000
No of Excavators	$90
Cost Per Unit	$7,411
Purchase Cost From Kobi	$6,100
From Financial perspective Purchasing from Kobi Excavators is better as Cost is less.
Answer to 2(b):
Overall Net Profit/(Loss)	$40,00,000
If Copper Division is Sold then Overall Profit / (Loss)
Total Revenue	$6,30,00,000
Less: Variable Costs	$3,40,00,000
Less: Direct Fixed Costs	$50,00,000
Less: Allocated Fixed Costs Unavoidable	$2,40,00,000
Overall Net Profit/(Loss)	$0
So, if Copper Division is Sold then Overall Profit will be 0 So it is not advisable to Sell Copper Division
Answer to 2©:
Break Even Points
	Copper	Bauxite	Gravel
Revenue	$2,20,00,000	$4,00,00,000	$2,30,00,000
Less: Variable Costs	$1,70,00,000	$2,20,00,000	$1,20,00,000
Contribution	$50,00,000	$1,80,00,000	$1,10,00,000
Contribution %	22.73	45.00	47.83
Fixed Costs:
Direct	$10,00,000	$30,00,000	$20,00,000
Allocated	$80,00,000	$80,00,000	$80,00,000
Total	$90,00,000	$1,10,00,000	$1,00,00,000
Break Even Point	$3,96,00,000	$2,44,44,444	$2,09,09,091
(Fixed Cost/Contribution %)