Question

DuPont Model: Comfy Chair Case

You work for an office supply company and your boss has a problem.

The new product development (NPD) team has designed a new office chair – The Comfy Chair. The NPD team wants to use a new material – Synthetic X – for the seat and arm covers. Right now, all of your office chairs use a nylon-based material. Synthetic X is an innovative product with very few suppliers, but has the potential to capture customers’ attention and drive additional sales.

Your boss is convinced that Synthetic X – which is 30% more expensive than the nylon-based material – is too expensive and will kill your company’s ROI. But the NPD team is arguing that additional sales will cover the extra cost of using Synthetic X.

The Marketing team is projecting sales for The Comfy Chair at 15,000 if the company sticks with its nylon-based material. If the company uses Synthetic X, the Marketing team projects sales of The Comfy Chair could reach 17,500. The Comfy Chair is priced at $275.

Your boss has a meeting with the Chief Operating Officer this afternoon and is getting ready. He has come up with following numbers:

Comfy Chair per unit costs

• Direct labor = $20
• Direct manufacturing overhead = $25
• Nylon-based seat and arm covers per unit = $30
• Other materials per unit excluding seat and arm covers = $55
• Other costs per unit associated with production = $100
• Currently, inventory costs are calculated as $30/unit for covering and $55/unit for other materials

Additional Information

• Relevant accounts receivable and cash = $850,000
• Relevant plant, property, and equipment = $8,000,000

Use the DuPont Model to compare the cost/sales numbers for The Comfy Chair using the nylon-based material versus the cost/sales numbers using Synthetic X.

1. What specific numbers would you give your boss as he goes into his meeting with the COO? Why?

2. What additional information might you like to know about this situation? Why?

3. What could your boss have done differently to avoid the kind of confrontation that is now underway between him and the NPD team?

Answer 1

Dupont model based analysis is used to evaluate the Return On Equity based on the drivers that can impact it

Return on Equity (ROE) = Profit Margin x Total Asset Turnover x Financial Leverage

A detailed analysis between the options of using Nylon based material vs Synthetic X is given below

a) Based on Dupont Model analysis, the use of Synthetic-X leads to improvement of Return on Investment. The Return for Comfy Chair based in Nylon material is 23.73% compared to higher return of 25.9% when the new product based on Synthetic-x as the improved sales offsets for the lower margin

b) A better analysis of the situation can be undertaken if more facts on the following can be arrived.

The Indirect production cost is assumed as $ 100 per unit. If the Indirect production cost is fixed in nature, it will further help to improve the margins if the output increases to 17,500 units instead of 15000 units. Accordingly, the per unit indirect production cost will be $ 85.71 (15000 x $ 100 / 17500) which will more than offsets the $9 increase per unit for seat and arm cover for using Synthetic-x.

c) A detailed Dupont Model analysis will help to evaluate the business decision better and hence having joint meetings with marketing and NPD team to evaluate the options would have helped to avoid the confrontation that arose as the discussion was only on the base of cost increase instead of the overall benefit after accounting for sales increase.