Question

Danna Martin, president of Mays Electronics, was concerned about the end-of-the year marketing report that she had just received. According to Larry Savage, marketing manager, a price decrease for the coming year was again needed to maintain the company's annual sales volume of integrated circuit boards (CBs). This would make a bad situation worse. The current selling price of $18 per unit was producing a $2-per-unit profit—half the customary $4-per-unit profit. Foreign competitors kept reducing their prices. To match the latest reduction would reduce the price from $18 to $14. This would put the price below the cost to produce and sell it. How could these firms sell for such a low price? Determined to find out if there were problems with the company's operations, Danna decided to hire a consultant to evaluate the way in which the CBs were produced and sold. After two weeks, the consultant had identified the following activities and costs: Activities Costs Setting up equipment $125,000 Materials handling 180,000 Inspecting products 122,000 Engineering support 120,000 Handling customer complaints 100,000 Filing warranties 170,000 Storing goods 80,000 Expediting goods 75,000 Using materials 500,000 Using power 48,000 Manual insertion labor* 250,000 Other direct labor 150,000 Total costs** $1,920,000 * Diodes, resistors, and integrated circuits are inserted manually into the circuit board. ** This total cost produces a unit cost of $16 for last year’s sales volume. The consultant indicated that some preliminary activity analysis shows that per-unit costs can be reduced by at least $7. Since the marketing manager had indicated that the market share (sales volume) for the boards could be increased by 50% if the price could be reduced to $12, Danna became quite excited. Required: 1. CONCEPTUAL CONNECTION: What is activity-based management? What phases of activity analysis did the consultant provide? What else remains to be done? 2. CONCEPTUAL CONNECTION: Identify as many nonvalue-added costs as possible. Compute the cost savings per unit that would be realized if these costs were eliminated. Was the consultant correct in the preliminary cost reduction assessment? Identify actions that the company can take to reduce or eliminate the nonvalue-added activities. Round your answers to two decimal places. 3. Compute the unit cost required to maintain current market share, while earning a profit of $4 per unit. Now compute the unit cost required to expand sales by 50%, assuming a per unit profit of $4. How much cost reduction would be required to achieve each unit cost? 4. Assume that further activity analysis revealed the following: switching to automated insertion would save $60,000 of engineering support and $90,000 of direct labor. Now, what is the total potential cost reduction per unit available from activity analysis? With these additional reductions, can Mays achieve the unit cost to maintain current sales? To increase it by 50%? What form of activity analysis is this: reduction, sharing, elimination, or selection? Round your answers to two decimal places. 5. CONCEPTUAL CONNECTION: Calculate income based on current sales, prices, and costs. Then calculate the income by using a $14 price and a $12 price, assuming that the maximum cost reduction possible is achieved (including Requirement 4’s reduction). What price should be selected? For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Answer 1

1. Activity based management is the method of identifying and evaluating the activities that go in running a business. It involves the following steps:

a. Identifying what activities are involved

b. Classifying the above as value and non value added

c. Improving value added and reducing non value activities

In this scenario, the consultant has performed only the 1st step of the process and given an estimate of how much per unit cost can be reduced

2. A value added activity is one which brings about a change in the product that is delivered to the customer. Non value added activities and the per unit cost savings on elimination of the same has been provided:

3. Unit cost required to maintain current market share, while earning a profit of 4 per unit.

Profit = 4 per unit

Selling price = 14 per unit

Cost price = 10 per unit

Therefore, total cost would 120,000*10 = 1,200,000. An amount of 720,000 needs to be reduced from cost.

If the sales increases by 50%, it is due to reduction in selling price to 12 per unit.

Selling price = 12

Profit = 4

Cost = 8

Total cost = 8 x 180,000 = 1,440,000 Cost needs to be reduced by 480,000

4. Potential cost reduction per unit assuming same market share of 120,000 units

Yes, Mays can achieve the unit cost required to maintain current sales. As cost would be 16-7.31 = 8.69 and a sleling price of 14 would give a profit of 5.31 per unit. This form of activity analysis is reduction and elimination as we are reducing costs and eliminating non value added costs.

5. Current income:

At price of 14:

At the price of 12

Cost reduction is being done to the extent of 877,000(727,000+150,000) for 120,000 units. The corresponding amount of cost increase and reduction will happen for 180,000 units. However, since the selling price is fixed at a lower rate of 12, the profit per unit and total profit will go down. Therefore, the price of 14 per unit should be selected for maximum profits.