3. Capstone, Inc. (Chapter 8)

Part 1 Capstone, Inc. mass-produces a special connector unit that it normally sells for $4.25. It sells approximately 45,000 of these units each year. The variable costs for each unit are $2.50. A company in Canada that has been unable to produce enough of a similar connector to meet customer demand would like to buy 25,000 of these units at $3.00 per unit. The production of these units is near full capacity at Capstone, Inc., so to accept the offer from the Canadian company would require temporarily adding another shift to its production line. To do this would increase variable manufacturing costs by $0.15 per unit. However, variable selling costs would be reduced by $0.25 a unit.

An irrigation company has asked for a special order of 3,000 of the connectors. To meet this special order, Capstone, Inc. would not need an additional shift, and the irrigation company is willing to pay $3.25 per unit.

Instructions (given the information in Part 1):

1. What are the consequences of Capstone, Inc. agreeing to provide the 25,000 units to the Canadian company? Would this be a wise “special order” to accept?
2. Should Capstone, Inc. accept the special order from the irrigation company?
3. What would be the consequences of accepting both special orders?

Part 2 Capstone, Inc. has discovered that a small fitting it now manufactures at a cost of $1.50 per unit could be bought elsewhere for $0.95 per unit. Capstone, Inc. has fixed costs of $0.25 per unit that cannot be eliminated by buying this unit. Capstone, Inc. needs 375,000 of these units each year.

If Capstone, Inc. decides to buy rather than produce the small fitting, it can devote the machinery and labor to making a timing unit it now buys from another company. Capstone, Inc. uses approximately 575 of these units each year. The cost of the unit is $13.00. To aid in the production of this unit, Capstone, Inc. would need to purchase a new machine at a cost of $2,500, and the cost of producing the units would be $9.90 a unit.

Instructions (given the information in Part 2)

1. Without considering the possibility of making the timing unit, evaluate whether Capstone, Inc. should buy or continue to make the small fitting.
2. (1) What is Capstone, Inc.’s opportunity cost if it chooses to buy the small fitting and start manufacturing the timing unit? (2) Would it be wise for Capstone, Inc. to buy the fitting and manufacture the timing unit? Explain.

Part 3 Capstone, Inc. is considering the replacement of an antiquated machine that has been slowing down production because of breakdowns and added maintenance. The operations manager estimates that this machine still has 2 more years of possible use. The machine produces an average of 45 units per day at a cost of $6.75 per unit, whereas other similar machines are producing twice that much. The units sell for $9.50. Sales are equal to production on these units, and production runs for 260 days each year. The replacement machine would cost $65,000, have a 2-year life and can produce 120 units per day.

Instructions (given the information in Part 3):

1. What are the consequences of Capstone, Inc. replacing the machine that is slowing down production because of breakdowns?

3. Capstone, Inc. (Chapter 8)

Part 1 Capstone, Inc. mass-produces a special connector unit that it normally sells for $4.25. It sells approximately 45,000 of these units each year. The variable costs for each unit are $2.50. A company in Canada that has been unable to produce enough of a similar connector to meet customer demand would like to buy 25,000 of these units at $3.00 per unit. The production of these units is near full capacity at Capstone, Inc., so to accept the offer from the Canadian company would require temporarily adding another shift to its production line. To do this would increase variable manufacturing costs by $0.15 per unit. However, variable selling costs would be reduced by $0.25 a unit.

An irrigation company has asked for a special order of 3,000 of the connectors. To meet this special order, Capstone, Inc. would not need an additional shift, and the irrigation company is willing to pay $3.25 per unit.

Instructions (given the information in Part 1):

1. What are the consequences of Capstone, Inc. agreeing to provide the 25,000 units to the Canadian company? Would this be a wise “special order” to accept?
2. Should Capstone, Inc. accept the special order from the irrigation company?
3. What would be the consequences of accepting both special orders?

Part 2 Capstone, Inc. has discovered that a small fitting it now manufactures at a cost of $1.50 per unit could be bought elsewhere for $0.95 per unit. Capstone, Inc. has fixed costs of $0.25 per unit that cannot be eliminated by buying this unit. Capstone, Inc. needs 375,000 of these units each year.

If Capstone, Inc. decides to buy rather than produce the small fitting, it can devote the machinery and labor to making a timing unit it now buys from another company. Capstone, Inc. uses approximately 575 of these units each year. The cost of the unit is $13.00. To aid in the production of this unit, Capstone, Inc. would need to purchase a new machine at a cost of $2,500, and the cost of producing the units would be $9.90 a unit.

Instructions (given the information in Part 2)

1. Without considering the possibility of making the timing unit, evaluate whether Capstone, Inc. should buy or continue to make the small fitting.
2. (1) What is Capstone, Inc.’s opportunity cost if it chooses to buy the small fitting and start manufacturing the timing unit?

(2) Would it be wise for Capstone, Inc. to buy the fitting and manufacture the timing unit? Explain.

Part 3 Capstone, Inc. is considering the replacement of an antiquated machine that has been slowing down production because of breakdowns and added maintenance. The operations manager estimates that this machine still has 2 more years of possible use. The machine produces an average of 45 units per day at a cost of $6.75 per unit, whereas other similar machines are producing twice that much. The units sell for $9.50. Sales are equal to production on these units, and production runs for 260 days each year. The replacement machine would cost $65,000, have a 2-year life, and can produce 120 units per day.

Instructions (given the information in Part 3):

1. What are the consequences of Capstone, Inc. replacing the machine that is slowing down production because of breakdowns?

9-1. Nealon Energy Corporation engages in the acquisition, exploration, development, and production of natural gas and oil in the continental United States. The company has grown rapidly over the last 5 years as it has expanded into horizontal drilling techniques for the development of the massive deposits of both gas and oil in shale formations. The company’s operations in the Haynesville shale (located in northwest Louisiana) have been so significant that it needs to construct a natural gas gathering and processing center near Bossier City, Louisiana, at an estimated cost of $70 million.

To finance the new facility, Nealon has $20 million in profits that it will use to finance a portion of the expansion and plans to sell a bond issue to raise the remaining $50 million. The decision to use so much debt financing for the project was largely due to the argument by company CEO Douglas Nealon Sr. that debt financing is relatively cheap relative to common stock (which the firm has used in the past). Company CFO Doug Nealon Jr. (son of the company founder) did not object to the decision to use all debt but pondered the issue of what cost of capital to use for the expansion project. There was no doubt that the out-of-pocket cost of financing was equal to the new interest that must be paid on the debt. However, the CFO also knew that by using debt for this project the firm would eventually have to use equity in the future if it wanted to maintain the balance of debt and equity it had in its capital structure and not become overly dependent on borrowed funds.

The following balance sheet reflects the mix of capital sources that Nealon has used in the past. Although the percentages would vary over time, the firm tended to manage its capital structure back toward these proportions:

The firm currently has one issue of bonds outstanding. The bonds have a par value of $1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity, and are selling for $1,035. Nealon’s common stock has a current market price of $35, and the firm paid a $2.50 dividend last year that is expected to increase at an annual rate of 6 percent for the foreseeable future.

1. What is the yield to maturity for Nealon’s bonds under current market conditions?

2. What is the cost of new debt financing to Nealon based on current market prices after both taxes (you may use a 21 percent marginal tax rate for your estimate) and flotation costs of $30 per bond have been considered?

3. What is the investor’s required rate of return for Nealon’s common stock? If Nealon were to sell new shares of common stock, it would incur a cost of $2.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common stock?

4. Compute the weighted average cost of capital for Nealon’s investment using the weights reflected in the actual financing mix (that is, $20 million in retained earnings and $50 million in bonds).

5. Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the $70 million in new capital, or $28 million, using $20 million in retained earnings and raising $22 million through a new equity offering.

6. If you were the CFO for the company, would you prefer to use the calculation of the cost of capital in part (d) or (e) to evaluate the new project? Why?

Using Microsoft Excel, construct a monthly proforma cash budget for your client for the first year of operations.

Product Selling Prices:

Oysters on half shell will sell for $8.25 each (dozen)
Fried Shrimp will sell for $10.25 (dozen)
Calamari will sell for $4.95 an order
Catfish Sandwich will sell for $5.95
Salads will sell for $4.50 each Fries sell for $1.25 per order
Sodas sell for $1.75 a bottle

Cost of Goods Sold:
The Catfish sandwich ingredients (fried catfish, cheese, sauce, bun etc.) cost $3.15 per sandwich.
Calamari cost per order $1.90.
The fresh Shrimp cost $7.19 per order from the supplier.
Oysters (sauce, lemon, oysters) cost $5.19 per order.
Salad ingredients (lettuce, tomatoes, cheese, etc.) cost $1.23 per salad serving
Frozen fries and oil average to $.67 per order
Sodas cost about $.7 per 16 oz. bottle
The building rent is $2775 per month.
Phone will cost about $220 per month.
Electricity should cost about $775 a month.
Insurance will be $850 a month.
Advertising and promotion will be $900 a month.

Operating Hours:
The diner will be open six days a week.
The diner will serve lunch and dinner and will be open from 11am – 9pm on weekdays (Monday – Friday).
It will need two hourly employee and an assistant manager (or manager) during these hours that the diner is open.
On Saturdays the restaurant will be open 11am – 11pm and will need three hourly employees and an assistant manager (or manger).
On Sundays the restaurant is only open dinner 4pm - 8pm.
One hourly employee and an assistant manager will be needed during these hours.
Your client will be the manager and draw a salary of $48,500 per year (includes benefits).
He will also work in the store during the busiest times, and fill in for the assistant manager on days off and sick days.
The assistant manager will receive a 2 salary of $37,500 per year (includes benefits).
The hourly workers will be paid $8.25 an hour. Monday through Fridays the owner expects an average of 15 customers an hour.
Saturdays and Sundays the owner expects an average of 40 customers an hour.
The restaurant is located near the beach so there is alot of foot traffic most days with Sunday being the slowest.

Demand Rate:
On average, 1/4 of all customer will buy shrimp, 1/4 of the customers will buy oysters, 1/4 will buy Calamari, and 1/2 customers will buy Catfish, 3/4 of them will buy a salad, all of them buy french fries, and every customer will purchase a soda.

Start-up costs for the diner includes:
Kitchen equipment: $16,250
Cash register and sales equipment: $1,250
Initial inventory: $5,500
Pre-opening marketing: $3,500
Diner fixtures (chairs, tables etc.): $4,500
Oil painting of your client’s momma to hang on the wall: $350
Licenses: $1,025 Security deposit: $6,500
First Insurance Payment: $850
Your client has $10,000 and plans to borrow the rest from the bank with a five-year loan at 5.1% interest.
You are to calculate the monthly loan payment using the appropriate financial function.
Assume a tax rate of 23% if Income Before Taxes (IBT) is equal to or is greater than $23,500.
Assume a tax rate of 13% if IBT is less than $23,500.
You are to calculate the monthly tax payment using the appropriate logical function.
Assume that sales will grow at an average of 2.25% per month.
Assume that each month contains 4.2 weeks.

Nealon Energy Corporation engages in the acquisition, exploration, development, and production of natural gas and oil in the continental United States. The company has grown rapidly over the last 5 years as it has expanded into horizontal drilling techniques for the development of the massive deposits of both gas and oil in shale formations. The company's operations in the Haynesville shale (located in northwest Louisiana) have been so significant that it needs to construct a natural gas gathering and processing center near Bossier City, Louisiana, at an estimated cost of $90 million.

To finance the new facility, Nealon has $30 million in profits that it will use to finance a portion of the expansion and plans to sell a bond issue to raise the remaining $60million. The decision to use so much debt financing for the project was largely due to the argument by company CEO Douglas Nealon Sr. that debt financing is relatively cheap relative to common stock (which the firm has used in the past). Company CFO Doug Nealon Jr. (son of the company founder) did not object to the decision to use all debt but pondered the issue of what cost of capital to use for the expansion project. There was no doubt that the out-of-pocket cost of financing was equal to the new interest that must be paid on the debt. However, the CFO also knew that by using debt for this project the firm would eventually have to use the equity in the future if it wanted to maintain the balance of debt and equity it had in its capital structure and not become overly dependent on borrowed funds.

The following balance sheet,

​

reflects the mix of capital sources that Nealon has used in the past. Although the percentages would vary over time, the firm tended to manage its capital structure back toward these proportions.

The firm currently has one issue of bonds outstanding. The bonds have a par value of

$1,000per bond, carry a coupon rate of 99percent, have 16 years to maturity, and are selling for $1,050.

Nealon's common stock has a current market price of $ 34, and the firm paid a $2.20dividend last year that is expected to increase at an annual rate of 88percent for the foreseeable future.

a. What is the yield to maturity for Nealon's bonds under current market conditions?

b.What is the cost of new debt financing to Nealon based on current market prices after both taxes (you may use a marginal tax rate of 35 percent for your estimate) and flotation costs of $40per bond have been considered?

Note : Use N=16 for the number of years until the new bond matures.

c.What is the investor's required rate of return for Nealon's common stock? If Nealon were to sell new shares of common stock, it would incur a cost of $2.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common stock?

d.Compute the weighted average cost of capital for Nealon's investment using the weights reflected in the actual financing mix (that is, $30 million in retained earnings and $60million in bonds).

e.Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40percent of the $90 million in new capital, or $36 million, using $30 million in retained earnings and raising $24 million through a new equity offering.

f.If you were the CFO for the company, would you prefer to use the calculation of the cost of capital in part (d ) or (e ) to evaluate the new project? Why?

Nealon Energy Corporation engages in the​ acquisition, exploration,​ development, and production of natural gas and oil in the continental United States. The company has grown rapidly over the last 5 years as it has expanded into horizontal drilling techniques for the development of the massive deposits of both gas and oil in shale formations. The​ company's operations in the Haynesville shale​ (located in northwest​ Louisiana) have been so significant that it needs to construct a natural gas gathering and processing center near Bossier​ City, Louisiana, at an estimated cost of $50 Million.

To finance the new​ facility, Nealon has $10 Million in profits that it will use to finance a portion of the expansion and plans to sell a bond issue to raise the remaining $40 million. The decision to use so much debt financing for the project was largely due to the argument by company CEO Douglas Nealon Sr. that debt financing is relatively cheap relative to common stock​ (which the firm has used in the​ past). Company CFO Doug Nealon Jr.​ (son of the company​ founder) did not object to the decision to use all debt but pondered the issue of what cost of capital to use for the expansion project. There was no doubt that the​ out-of-pocket cost of financing was equal to the new interest that must be paid on the debt.​ However, the CFO also knew that by using debt for this project the firm would eventually have to use equity in the future if it wanted to maintain the balance of debt and equity it had in its capital structure and not become overly dependent on borrowed funds. The following balance sheet, reflects the mix of capital sources that Nealon has used in the past. Although the percentages would vary over​ time, the firm tended to manage its capital structure back toward these proportions.

The firm currently has one issue of bonds outstanding. The bonds have a par value of $1000 per bond, carry a coupon rate of 6%, have 16 years to maturity, and are selling for $1055. Nealon's common stock has a current market price of $42, and the firm paid a $2.20 dividend last year that is expected to increase at an annual rate of 6% for the foreseeable future.

BONDS 40%

COMMON STOCK 60%

a. What is the yield to maturity for​ Nealon's bonds under current market​ conditions?

b. What is the cost of new debt financing to Nealon based on current market prices after both taxes​ (you may use a marginal tax rate of 36% for your​ estimate) and flotation costs of $30 per bond have been considered?

Note​: Use N=16 for the number of years until the new bond matures.

c. What is the​ investor's required rate of return for​ Nealon's common​ stock? If Nealon were to sell new shares of common​ stock, it would incur a cost of

$3.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common​stock?

d. Compute the weighted average cost of capital for​ Nealon's investment using the weights reflected in the actual financing mix​(that is,

$10 million in retained earnings and $40 million in​ bonds).

e. Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the

$50 million in new​ capital, or $20

​million, using $20 million in retained earnings and raising $10 million through a new equity offering.

f. If you were the CFO for the​ company, would you prefer to use the calculation of the cost of capital in part (d​) or (e​) to evaluate the new​ project? Why?

​

Case Study 2 Construction

Fred’s Sheds

Fred Smith, the founder and chief executive of Fred’s Sheds, received a phone call one afternoon from a local farmer, Mr Jones, requesting a quote to design and build a large storage shed on his property. Fred asked Mr Jones what size and type of shed he would like, when he wanted work to commence, and when he wanted it completed.

Mr Jones told him that he required a large shed, big enough to store his tractor and utility vehicle, and spaces for a workbench, tools and fertilisers.  

He also specified that the shed must have power, water and a toilet. He requested that the shed be made of high quality materials, because twice in the previous ten years some of the other sheds on his property had been damaged by inclement weather, costing him many thousands of dollars in repairs.

Mr Jones wanted work to commence in 6 week’s time and would like the job completed no more than 3 weeks after that so he would have a place to store his vehicles before the winter rains came.

Mr Jones asked Fred to come up with a design and quote to build his shed and asked him to present them to him at a meeting at his house in a week’s time.

He told Fred that he was obtaining three quotes from three different builders, and that he would select his preferred builder based on four criteria.

These were quality, the ability to start and finish on time, and cost.

Mr Jones said he would like to spend no more than $40,000 on the shed, but would consider alternate proposals that were a little higher in price if they could exceed his minimum evaluation criteria.

As soon as Fred hung up the phone his mind started to think of all the different tasks he would need to do to win and complete the job. Having built many sheds before, he was confident he had the project management skills to build a shed that met Mr Jones’s extensive criteria. He jotted down some of his thoughts on a notepad so that he would not forget anything.

First of all, Fred knew he would have to come up with a winning design, so he would need to put his designer, Karen, on the job of coming up with some innovative designs.

Fred would also have to source higher quality building materials than he usually used because, although Fred always used good materials, he thought he would try to use the best possible materials, if it was cost effective, to give him the edge in meeting Mr Jones’s stringent evaluation criteria over his two competitors.

Fred also knew that he would need to plan the human resources necessary to complete the job in the timeframe required. Some of his other construction projects were nearing completion, so it would not be too much of a problem getting some of his construction workers to start in 6 weeks’ time. However, Fred was not sure about the availability of his subcontractors, Eddie the electrician, Bob the plumber, Gary the glazier and Tony his fencing contractor and odd job man, because business was booming and they were all very busy.

If he was successful in winning the contract, Fred knew that there would still be lots of work to be done. After signing the contract, he would need to submit a Development Application and construction certificate to the local council and await their approval.

Mr Jones’s final selections for colour and style of shed materials would need to be finalised and a deposit received prior to commencing work.

Once all that had been accomplished, Fred and his team of four would have to prepare the site for construction. This would involve performing underground cable service checks, and perhaps contracting a surveyor to locate existing boundaries as the shed was going to be built close to the boundary with Mrs Mitchell’s neighbouring property.

The site would need to be cleared, temporary site facilities such as a toilet, site fencing, power and water would have to be established, the site set out and the formwork built. Following this, the site would be excavated.

While the excavation was taking place, Fred would need to remember to book a council inspection for the formwork prior to concreting, as well as booking the concrete truck, a date for the shed to be delivered, a date for the shed installation team to put the shed into place, and dates for his subcontractors to come and install power and water.

After pouring the concrete and finish, his team would need to strip the formwork. At this time Fred could invoice Mr Jones for a progress payment as this represented a milestone in the project. Following this the shed could be delivered and installed,

Eddie the electrician could be called in to connect the mains power, Bob the plumber could connect the water and install the toilet and Gary the glazier could install the windows. While they were busy doing that, Fred and his team could start clearing the site, removing any rubbish and the temporary site amenities.

Once all these tasks were accomplished, the job would be at practical completion. Fred would then meet with Mr Jones, present him with a final bill and handover the keys to the shed. Fred smiled to himself feeling confident that he would beat his two competitors to the job and thinking that he would soon have another satisfied customer.

Complete the project budget in the resources and cost template.

******** I need just a simple example

Resource and Cost Template

Q.5

In defining the detailed maintenance plan and establishing criteria for equipment design (and system support),it is necessary to determine whether it is economicy feasible to repair certain assemblies or to discard them when failures occur. If the decision is to accomplish repair, it is appropriate to determine the maintenance level at which the repair should be accomplished (i.e., intermediate level maintenance or depot level maintenance). For the purposes of this exercise, Assembly A-1 (one of 15 assemblies in Unit B of system XYZ) is to be evaluated in terms of the three options. The following information is provided to facilitate the evaluation of the decision

System XYZ is installed in each of 60 aircraft that are deployed at five operational bases over an 8-year period. System XYZ will be utilized on an average of 4 hours per day, 365 days per year, and the total system operating time is 452,600 hours.

System XYZ is packaged in three units: Unit A, Unit B, and Unit C. When corrective maintenance is required , a built-in self-test capability enables rapid checkout and fault isolation to the unit level. In the event of a no-go or failure condition, the applicable unit is re­moved and replaced with a spare. The faulty removed unit is sent to the intermediate-level maintenance shop (located at the operational base) for corrective maintenance. Unit repair is accomplished through fault isolation to the applicable assembly (e.g., Assembly A-1), removal of the faulty assembly and replacement with a spare, and checkout of the unit to verify satisfactory operation.The faulty assembly must now be processed in accor­ dance with the designated maintenance plan.

Pertinent data associated with Assembly A-1 are noted below.

a. The estimated acquisition cost for Assembly A-1 (to include design and develop­ ment cost and production cost) is $1700 if the assembly is designed to be repairable, and $1600 if the assembly is designed to be discarded at failure.

b. The estimated failure rate (or corrective maintenance rate) is 0.00045 failure per hour of system operation.

c. When failures occur, repair is accomplished by one technician assigned on a full­ time basis (i.e.,for the duration of the predicted elapsed active repair time). The estimated Mct is 3 hours. The labor rate is $20 per labor-hour for intermediate maintenance and $30 per labor-hour for depot maintenance.

d. Supply support involves three categories of cost: (1) the cost of spare assemblies in the pipeline, (2) the cost of spare components to enable the repair of faulty assemblies, and (3) the cost of inventory maintenance. Assume that five spare assemblies will be required in the pipeline when maintenance is accomplished at the intermedi­ate level, and that 10 spares will be required when maintenance is accomplished at the depot level. For component spares, assume a material cost of $50 per maintenance action. The estimated cost of inventory maintenance will be 20% of the in­ ventory value.

e. When assembly repair is accomplished , special test and support equipment is required for fault diagnosis and checkout. The cost per set is $12,000, which includes acquisition cost and runortized maintenance cost.

f. Transportation and handling cost is considered to be negligible when maintenance is accomplished at the intermediate level; however, assembly maintenance accom­plished at the depot level will involve an extensive runount of transportation. For depot maintenance, assume $150 per 100 pounds per one-way trip (independent of the distance), and that the packaged assembly weighs 20 pounds.

g. The allocation for Assembly A-1 relative to maintenance facility cost is categorized in terms of (1) an initial fixed cost, and (2) a sustaining recurring cost proportional to facility use requirements. The initial fixed cost is $1000 per installation, and the assumed usage cost allocation is $1.00 per direct maintenance labor-hour at the in­ termediate level and $1.50 per direct maintenance labor-hour at the depot level.

h. Technical data requirements will constitute (1) the maintenance instructions to be included in the technical manual to support assembly repair activities and (2) the failure reporting and maintenance data covering each maintenance action in the field. Assume that the cost for preparing and distributing maintenance instructions is $1000 and that the cost for field maintenance data is $25 per maintenance action.

i. There will be some initial formal training costs associated with maintenance personnel when the assembly repair option is considered. Assume 30 student-days of formal training for intermediate-level maintenance and 6 student-days for depot-level maintenance. The cost of training is $150 per student-day.

j. As a result of maintenance actions, there will be a requirement for the disposal of ei­ther faulty assemblies or faulty components. The assumed disposal cost is $20 per assembly and $2 per component.

Evaluate Assembly A-1 (based on the information provid­ed previously) and make a recommendation. Should Assembly A-1 be repaired at the intermediate level of maintenance, repaired at the depot level of maintenance, or discarded at failure? Show the cost for each of the cost results for each of the the three strategies as a result of the conditions above. use this work sheet to conduct the evualuation. Select the strategy that yields the lowest cost for assembly A-1

Case 11A-7 Transfer Pricing; Divisional Performance [LO11-5]

Weller Industries is a decentralized organization with six divisions. The company’s Electrical Division produces a variety of electrical items, including an X52 electrical fitting. The Electrical Division (which is operating at capacity) sells this fitting to its regular customers for $10.00 each; the fitting has a variable manufacturing cost of $5.23.

The company’s Brake Division has asked the Electrical Division to supply it with a large quantity of X52 fittings for only $8.00 each. The Brake Division, which is operating at 50% of capacity, will put the fitting into a brake unit that it will produce and sell to a large commercial airline manufacturer. The cost of the brake unit being built by the Brake Division follows:

Although the $8.00 price for the X52 fitting represents a substantial discount from the regular $10.00 price, the manager of the Brake Division believes the price concession is necessary if his division is to get the contract for the airplane brake units. He has heard “through the grapevine” that the airplane manufacturer plans to reject his bid if it is more than $58 per brake unit. Thus, if the Brake Division is forced to pay the regular $10.00 price for the X52 fitting, it will either not get the contract or it will suffer a substantial loss at a time when it is already operating at only 50% of capacity. The manager of the Brake Division argues that the price concession is imperative to the well-being of both his division and the company as a whole.

Weller Industries uses return on investment (ROI) to measure divisional performance.

Required:

1. Assume that you are the manager of the Electrical Division.

a. What is the lowest acceptable transfer price for the Electrical Division?

b. Would you supply the X52 fitting to the Brake Division for $8.00 each as requested?

2. Calculate the net positive effect on the company's profit per brake unit the Electrical Division to supply the fittings to the Brake Division and if the airplane brakes can be sold for $58?

3. In principle, within what range would that transfer price lie?

(For all requirements, enter your "Financial Disadvantage" amounts as a negative value and round your final answers to 2 decimal places.)

Northwood Company manufactures basketballs. The company has a ball that sells for $23. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable costs are high, totaling $15 per ball, of which 65% is direct labor cost.

Last year, the company sold 30,000 of these balls, with the following results:                   

1. Compute the CM ratio

2. Compute the Break-even point

3. Find the Margin of Safety at the last year's sales.

4. Due to an increase in labor rates, the company estimates that variable costs will increase by $2 per ball next year. If this change takes place and the selling price per ball remains constant at $23, what will be the new CM ratio and break-even point in balls?

5. Refer to the data in (point 4) above. If the expected change in variable costs takes place, how many balls will have to be sold next year to earn the same net operating income $90,000 as last year?

6. Refer again to the data in (point 4) above. The president feels that the company must raise the selling price of its basketballs. If Northwood Company wants to maintain the same CM ratio as last year, what selling price per ball must it charge next year to cover the increased labor costs?

7. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The new plant would slash variable costs per ball by 40%, but it would cause fixed costs per year to double. If the new plant is built, what would be the company’s new CM ratio and new break-even point in balls?

8. Refer to the original data. Find the multi-product breakeven point, if the company decides to produce another types of balls (of higher quality) it is expected that the sell at a price of $40 of which 60% is variable cost and no more fixed cost is required. If the company is expecting to have sales at a value of 890,000 of which this new balls would be about 20% of the total sales value. All information related to the original types of balls remains the same.