Question

Pinkerton Steelworks manufactures high quality bearings for large construction equipment. An
analysis reveals that sales for one of the company’s main products, the super bearing, is
declining due to aggressive pricing by competitors. Pinkerton's product sells for $525 whereas
the competition's comparable part is selling for close to $425. Consultants have determined that a
price drop to $400 is necessary to regain market share and annual sales of 1,000 units.
Cost data based on sales of 1,000 super bearings:

	Budget quantity	Actual quantity	Actual cost
Direct materials	10,000 lbs	11,000 lbs	$55,800
Direct labor	4,600 hrs	5,200 hrs	155,000
Inspections	2,500 hrs	3,000 hrs	57,000
Materials handling	100 moves	120 moves	35,000
Mechanical assembly	3,000 hrs	4,000 hrs	140,000

1. Calculate the current cost and profit per unit.
2. How much of the current cost per unit is attributable to non-value added activities?
3. Calculate the new target cost per unit for a sales price of $400 if the profit per unit is
maintained.
4. What strategy do you suggest for Pinkerton to attain the target cost per unit?

Answer 1

1. Current Cost per unit

Direct Materials = 55,800/1,000 units = $55.8 per unit

Direct Labour = 155,000/1,000 units = $155 per unit

Inspections = 57,000/1,000 units = $57 per unit

Materials handling = 35,000/1,000 units = $35 per unit

Mechanical Assembly = 140,000/1,000 units = $140 per unit

Total cost per unit = $442.8 per unit

Profit per unit = Sales price per unit - Total cost per unit

= 525 - 442.8

= $82.20 per unit

2. Non value added activities:-

1) Inspections = $57

2) Materials handling = $35

Total per unit = $92 per unit

3. New target cost price if the same profit of $82.20 per unit is to be maintained

Target Cost Price = $400 - $82.20

= $317.80

4. We suggest the following strategy to Pinkerton to attain the target cost price:-

a. Inspection of the goods to be done by the labour themselves in their dedicated work hours. By this, the inspection cost which is non value added can be removed.

b. Materials to be moved for just 10-15 times from here are there and this will reduce the materials handling cost to a great extent.

c. Make labour more efficient to complete the production work within the budgeted time.

d. Reduce materials wastage, use materials judiciously.