Question

Cobalt Industries makes tennis balls. Its only plant can produce up to 2.5 million cans of balls per year. Current production is 2 million cans. Annual manufacturing, selling, and administrative fixed costs total $700,000. The variable cost of making and selling each can of balls is $1.00. Stockholders expect a 12% annual return on the company’s $3 million of assets.

                        Required:

a) What is Cobalt’s current full cost of making and selling 2 million cans of tennis balls? What is the current full unit cost of each can of tennis balls?

b) Assume Cobalt is a price-taker, and the current market price is $1.45 per can of balls (this is the price at which manufacturers sell to retailers). Given Cobalt Industries’ current costs will the company reach stockholders’ profit goals?

c) Suppose Cobalt could spend an extra $100,000 on advertising to differentiate its product so that it could be a price setter. Assuming the original volume and costs, plus the $100,000 of new advertising costs, what cost-plus price will Cobalt want to charge for a can of balls to realize stockholders’ profit goals?

d) Nike has just asked Cobalt to supply the company with 400,000 cans of balls at a special order price of $1.20 per can. Nike wants Cobalt to package the balls under the Nike label (Cobalt will imprint the Nike logo on each ball and can). Cobalt will have to spend $10,000 to change the packaging machinery. Assuming the original volume and costs, should Cobalt Industries accept this special order?

Answer 1

a). No. of units as per current production = 2,000,000
Variable Cost per unit of making and selling = $1
Fixed costs per annum = $700,000
Total costs of making and selling 2 million cans = 2,000,000*1 + 700,000 = $2,700,000
Current full unit costs of each can = 2,700,000/ 2,000,000 = $1.35

b). Current market price = $1.45 per can
Current full unit costs = $1.35 per can
Profit = 0.10 * 2,000,000 = $200,000
Expected annual return of stakeholder's =$3,000,000 * 12% = $360,000
Company is unable to reach stakeholder's profit goals at current conditions.

c).If company wants to reach profit goal of $360000 and is ready spend extra amount of $100000. The selling price must be:
S.P*2,000,000 - 2,700,000 - 100,000 = 360,000
S.P *2,000,000 = 3,160,000
S.P = 3,160,000/2,000,000 = $1.58 per can
Hence the Selling price must be $1.58 per can

d). Special order price = $1.20 per can
Additional spending = $10000
Surplus capacity available = 2.5 million - 2 million = 500,000 units
Special order requirement = 400,000 units
Relevant cost for special order = $1 per unit (because fixed cost are sunk cost which will anyway incur wheather of not company accept the order )
Profit from the order = $0.2 *400,000 -$10000 = $70000
Hence the Cobalt must accept the order which gives it $70000 profit additional.