PPM 3-2

1. NCHEM

As the exams are tested as CBE, candidates will not have to draw a graph. However, it is good practice to attempt a question such as this as part of a robust revision programme. In the exam, graphs will be part of the question scenario and candidates may be asked to provide further calculation or analysis.

Nchem refines crude oil into petrol. The refining process uses two types of crude oil – heavy and light. A mixture of these oils is blended into either Super or Regular petrol.

In the refining process one gallon (g) of Super is made from 0.7 g of heavy crude and 0.5 g of light crude. One gallon of Regular is made from 0.5 g of heavy crude and 0.7 g of light crude oil. (There is a refining loss of 0.2 g in each case.)

At present, 5,000 g of heavy crude and 6,000 g of light crude oil are available for refining each day. Market conditions suggest that at least two-thirds of the petrol refined should be Super. The company makes contribution of $0.25 per gallon of Super and $0.10 per gallon of Regular.

Required:

A. State the objective function and three constraints, one for heavy crude, one for light crude and one for market conditions.

B. Graph the constraints and shade the feasible region.

C. Calculate the optimum production plan and the resulting total contribution, and briefly explain your answer.

2. HS CO

Just over two years ago, HS Co was the first company to produce a specific ‘off-the-shelf’ accounting software package. The pricing strategy for the packages, decided on by the managing director, was to add a 50% mark-up to the budgeted full cost of the packages. The company achieved and maintained a significant market share and high profits for the first two years.

Budgeted information for the current year (Year 3) was as follows.

Production and sales 15,000 packages

Full cost $400 per package

At a recent board meeting, the finance director reported that although costs were in line with the budget for the current year, profits were declining. They explained that the full cost included $80 for fixed overheads. This figure had been calculated by using an overhead absorption rate based on labour hours and the budgeted level of production of 15,000 packages. They pointed out that this was much lower than the current capacity of 25,000 packages.

The marketing director stated that competitors were beginning to increase their market share. They also reported the results of a recent competitor analysis which showed that when HS Co announced its prices for the current year, the competitors responded by undercutting them by 15%. Consequently, they commissioned an investigation of the market. They informed the board that the market research showed that at a price of $750 there would be no demand for the packages but for every $10 reduction in price the demand would increase by 1,000 packages.

The managing director appeared to be unconcerned about the loss of market share and argued that profits could be restored to their former level by increasing the mark-up.

Required:

A. Discuss the managing director’s pricing strategy in the circumstances described above.

B. Suggest and explain two alternative strategies that could have been implemented at the launch of the packages.

C. Based on the data supplied by the market research, derive a straight-line demand equation for the packages.

D. HS’s total costs (TC) can be modelled by the equation TC = 1,200,000 + 320Q. Explain the meaning of this equation.

E. Explain what is meant by price elasticity of demand and explain the implications of elasticity for HS’s pricing strategy.

3. CUT AND STITCH

Cut and Stitch (CS) make two types of suits using skilled tailors (labour) and a delicate and unique fabric (material). Both the tailors and the fabric are in short supply and so the accountant at CS has correctly produced a linear programming model to help decide the optimal production mix.

The model is as follows:

Variables:

Let W = the number of work suits produced

Let L = the number of lounge suits produced

Constraints:

Tailors’ time: 7W + 5L ≤ 3,500 (hours) – this is line T on the diagram

Fabric: 2W + 2L ≤ 1,200 (metres) – this is line F on the diagram

Production of work suits: W ≤ 400 – this is line P on the diagram

Objective is to maximise contribution subject to:

C = 48W + 40L

On the diagram provided the accountant has correctly identified OABCD as the feasible region

and point B as the optimal point.

Required:

A. Find by appropriate calculation the optimal production mix and related maximum contribution that could be earned by CS.

B. Calculate the shadow prices of the fabric per metre and the tailor time per hour.

The tailors have offered to work an extra 500 hours provided that they are paid three times their normal rate of $1.50 per hour at $4.50 per hour.

C. Briefly discuss whether CS should accept the offer of overtime at three times the normal rate.   

D. Calculate the new optimum production plan if maximum demand for W falls to 200 units.

4. COSMO CO

The Cosmo Co is a company producing a variety of cosmetic creams and lotions. The creams and lotions are sold to a variety of retailers at a price of $23.20 for each jar of face cream and $16.80 for each bottle of body lotion. Each of the products has a variety of ingredients, with the key ones being silk powder, silk amino acids and aloe vera. Six months ago, silk worms were attacked by disease causing a huge reduction in the availability of silk powder and silk amino acids. The Cosmo Co had to dramatically reduce production and make part of its workforce, which it had trained over a number of years, redundant.

The company now wants to increase production again by ensuring that it uses the limited ingredients available to maximise profits by selling the optimum mix of creams and lotions. Due to the redundancies made earlier in the year, supply of skilled labour is now limited in the short-term to 160 hours (9,600 minutes) per week, although unskilled labour is unlimited. The purchasing manager is confident that they can obtain 5,000 grams of silk powder and 1,600 grams of silk amino acids per week. All other ingredients are unlimited.

The following information is available for the two products:

Cream                       Lotion

Materials required: silk powder (at $2.20 per gram)                           3 grams                     2 grams

– silk amino acids (at $0.80 per gram)                                                     1 gram                    0.5 grams

– aloe vera (at $1.40 per gram)                                                                4 grams                    2 grams

Labour required: skilled ($12 per hour)                                                4 minutes                 5 minutes

– unskilled (at $8 per hour)                                                                     3 minutes               1.5 minutes

Each jar of cream sold generates a contribution of $9 per unit, whilst each bottle of lotion generates a contribution of $8 per unit. The maximum demand for lotions is 2,000 bottles per week, although demand for creams is unlimited. Fixed costs total $1,800 per week. The company does not keep inventory although if a product is partially complete at the end of one week, its production will be completed in the following week.

The following graph has been accurately drawn:

Required:

A. Calculate the optimum number of each product that the Cosmo Co should make per week, assuming that it wishes to maximise contribution. Calculate the total contribution per week for the new production plan. All workings MUST be rounded to 2 decimal places.

B. Calculate the shadow price for silk powder and the slack for silk amino acids. All workings MUST be rounded to 2 decimal places.

5. THE LEVER HOTEL

The Lever Hotel is situated in a major city close to many theatres and restaurants.

The Lever Hotel has 25 double bedrooms, and it charges guests $180 per room per night, regardless of single or double occupancy. The hotel’s variable cost is $60 per occupied room per night.

The Lever Hotel is open for 365 days a year and has a 70% budgeted occupancy rate. Fixed costs are budgeted at $600,000 a year and accrue evenly throughout the year.

During the first quarter (Q1) of the year the room occupancy rates are significantly below the levels expected at other times of the year with the Lever Hotel expecting to sell 900 occupied room nights during Q1. Options to improve profitability are being considered, including closing the hotel for the duration of Q1 or adopting one of two possible projects as follows:

Project 1 – Theatre package

For Q1 only the Lever Hotel management would offer guests a ‘theatre package’. Couples who pay for two consecutive nights at a special rate of $67·50 per room night will also receive a pair of theatre tickets for a payment of $100. The theatre tickets are very good value and are the result of long negotiation between the Lever Hotel management and the local theatre. The theatre tickets cost the Lever Hotel $95 a pair. The Lever Hotel’s fixed costs specific to this project (marketing and administration) are budgeted at $20,000.

The hotel’s management believes that the ‘theatre package’ will have no effect on their usual Q1 customers, who are all business travellers and who have no interest in theatre tickets, but will still require their usual rooms.

Project 2 – Restaurant

There is scope to extend the Lever Hotel and create enough space to operate a restaurant for the benefit of its guests. The annual costs, revenues and volumes for the combined restaurant and hotel are illustrated in the following graph:

Note. The graph does not include the effect of the ‘Theatre package’ offer.

Required:

A. Using the current annual budgeted figures, and ignoring the two proposed projects, calculate the breakeven number of occupied room nights and the margin of safety as a percentage.

B. Ignoring the two proposed projects, calculate the budgeted profit or loss for Q1 and explain whether the hotel should close for the duration of Q1.

C. Calculate the breakeven point in sales value of Project 1 and explain whether the hotel should adopt the project.

D. Using the graph, quantify and comment upon the financial effect of Project 2 on the Lever Hotel.

6. RGB CO

RGB Co operates a retail store selling spares and accessories for the car market. The store has previously only opened for six days per week for the 50 working weeks in the year, but RGB Co is now considering also opening on Sundays.

The sales of the business on Monday through to Saturday averages at $10,000 per day with average gross profit of 70% earned.

RGB Co expects that the gross profit % earned on a Sunday will be 20 percentage points lower than the average earned on the other days in the week. This is because they plan to offer substantial discounts and promotions on a Sunday to attract customers. Given the price reduction, Sunday sales revenues are expected to be 60% more than the average daily sales revenues for the other days. These Sunday sales estimates are for new customers only, with no allowance being made for those customers that may transfer from other days.

RGB Co buys all its goods from one supplier. This supplier gives a 5% discount on all purchases if annual spend exceeds $1,000,000.

It has been agreed to pay time and a half to sales assistants that work on Sundays. The normal hourly rate is $20 per hour. In total five sales assistants will be needed for the six hours that the store will be open on a Sunday. They will also be able to take a half-day off (four hours) during the week. Staffing levels will be allowed to reduce slightly during the week to avoid extra costs being incurred.

The staff will have to be supervised by a manager, currently employed by the company, and paid an annual salary of $80,000. If he works on a Sunday, he will take the equivalent time off during the week when the assistant manager is available to cover for him at no extra cost to RGB Co. He will also be paid a bonus of 1% of the extra sales generated on the Sunday project.

The store will have to be lit at a cost of $30 per hour and heated at a cost of $45 per hour. The heating will come on two hours before the store opens in the 25 ‘winter’ weeks to make sure it is warm enough for customers to come in at opening time. The store is not heated in the other weeks.

The rent of the store amounts to $420,000 annum.

Required:

A. Calculate whether the Sunday opening incremental revenue exceeds the incremental costs over a year (ignore inventory movements) and on this basis reach a conclusion as to whether Sunday opening is financially justifiable.

B. Discuss whether the manager’s pay deal (time off and bonus) is likely to motivate him.

C. Briefly discuss whether offering substantial price discounts and promotions on Sunday is a good suggestion.

7. KINGSTON PARK RESORT

Kingston Park Resort is a new theme park resort located in the country of Cyprus. The resort is made up of a theme park, a hotel and an indoor water park. The resort opened two months ago and is already very popular.

As all theme parks in Cyprus are required, by law, to shut down in the colder month of January because of the risk of accidents, Kingston Park Resort must decide whether to shut down the whole resort or just the theme park. It could choose to keep open the hotel and/or the water park.

Since Kingston Park Resort has not been open for long, there is limited historical data available about costs and revenues. However, based on the last two months, the following average monthly data is available:

Hotel

Number of rooms                                                                     120

Average room rate per night                                                 $100

Average occupancy rate per month                                      90%

Average nightly spend on ‘extras’ per room                        $20

Contribution margin for ‘extras’*                                          60%

Water park

Number of visitors per month                                           12,000

Admission price per visitor                                                   $21

Average spend on ‘extras’ per visitor                                  $12

Contribution margin for ‘extras’*                                        60%

*’Extras’ includes anything purchased by the customer not included in the room rate or admission price.

Management estimates that, for January, the average room rate per night would need to decrease by 30% and the admission price for the water park by 20%. With such reductions, it is estimated that an occupancy rate of 50% would be achieved for the hotel and that the number of visitors to the water park would be 52% lower than current levels. The average nightly spend on ‘extras’ per room of $20 at the hotel and $12 per customer at the water park is expected to remain unchanged.

The running costs for the hotel and water park for each of the last two months are as follows:

Notes                          Hotel                  Water park

$                               $

Staff costs                                                         1                           120,000                    75,600

Maintenance costs                                          2                            14,600                      6,000

Power costs                                                      3                            20,000                     18,000

Security costs                                                   4                            13,600                      8,000

Water costs                                                      5                            12,900                     12,100

Notes

• Staff costs

Permanent staff Included in the staff costs for the hotel is the salary of $30,000 per annum for the hotel manager and $24,000 per annum for the head chef. These are both permanent members of staff who are paid for the full year regardless of their working hours.

The water park employs one permanent member of staff, the manager, on a salary of $24,000 who is also paid for the full year regardless of his working hours.

Temporary staff

The remaining staff costs relate to temporary staff who are only paid for the hours they work. If the hotel stays open in January, half of these staff members will continue to work their current hours because their jobs are largely unaffected by guest occupancy rates. However, the other half of the staff will work proportionately less hours to reflect the 50% occupancy rate in January as opposed to the 90% occupancy rate of the last two months.

At the water park, the temporary staff’s working hours will fall according to the number of visitors, hence a fall of 52% would be expected for January.

• Maintenance costs

Maintenance is undertaken by a local company, ‘Techworks’, which bills Kingston Park Resort for all work carried out each month. If the hotel and water park are closed, Techworks will instead be paid a flat fee for the month of $4,000 for the hotel and $2,000 for the water park.

• Power costs

Electricity Kingston

Park Resort pays a fixed monthly charge for electricity of $8,000 for the hotel and $7,000 for the water park, all year round.

Gas

The gas charges relate to heating and include a fixed charge of $2,200 per month for the hotel and $1,500 per month for the water park. The remainder of the gas charges is based solely on usage and would be expected to increase by 50% in January because of the colder weather.

• Security costs

If the hotel and water park close, no changes will be made to the current arrangements for security whilst the premises are empty.

• Water costs

It is estimated that water costs for the hotel would fall to $6,450 for the month if it remains open in January. However, the water costs for the water park would be expected to remain at their current level. If the hotel and water park were closed, all water would be turned off and no charges would arise.

Required:

A. Calculate the incremental cash flows, for the month of January (31 days), if Kingston Park Resort decides to keep open:

i) The hotel;

ii) The water park.

In each case, state whether it should remain open or should close.

B. Discuss any other factors which Kingston Park Resort should consider when making the decision in part (a).

8. EMC CO

EMC Co is a health food company producing and selling three types of high-energy products: cakes, shakes and cookies, to gyms and health food shops. Shakes are the newest of the three products and were first launched three months ago. Each of the three products has two special ingredients, sourced from a remote part of the world. The first of these, Singa, is a super-energizing rare type of caffeine. The second, Beta, is derived from an unusual plant believed to have miraculous health benefits.

EMC Co’s projected manufacture costs and selling prices for the three products are as follows:

For each of the three products, the expected demand for the next month is 11,200 cakes, 9,800 cookies and 2,500 shakes.

The total fixed costs for the next month are $3,000.

EMC Co has just found out that the supply of Beta is going to be limited to 12,000 grams next month. Prior to this, EMC Co had signed a contract with a leading chain of gyms, Encompass Health, to supply it with 5,000 shakes each month, at a discounted price of $5.80 per shake, starting immediately. The order for the 5,000 shakes is not included in the expected demand levels above.

Required:

A. Assuming that EMC Co keeps to its agreement with Encompass Health, calculate the shortage of Beta, the resulting optimum production plan and the total profit for next month.

One month later, the supply of Beta is still limited, and EMC Co is considering whether it should breach its contract with Encompass Health so that it can optimise its profits.

Required:

B. Discuss whether EMC Co should breach the agreement with Encompass Health.

Note: No further calculations are required.

Several months later, the demand for both cakes and cookies has increased significantly to 20,000 and 15,000 units per month respectively. However, EMC Co has lost the contract with Encompass Health and, after suffering from further shortages of supply of Beta, Singa and of its labour force, EMC Co has decided to stop making shakes at all. EMC Co now needs to use linear programming to work out the optimum production plan for cakes and cookies for the coming month. The variable ‘x’ is being used to represent cakes and the variable ‘y’ to represent cookies.

The following constraints have been formulated and a graph representing the new production problem has been drawn:

Singa: 0.25x + 0.5y ≤ 12,000

Beta: 0.5x + 0.2y ≤ 12,500

Labour: 0.1x + 0.12y ≤ 3,000

x ≤ 20,000

y ≤ 15,000

x, y ≥0

Required:

C.

i. Explain what the line labelled ‘C = 2.6x + 1.75y’ on the graph is and what the area represented by the points 0ABCD means.

ii) Explain how the optimum production plan will be found using the line labelled ‘C = 2.6x + 1.75y’ and identify the optimum point from the graph.

iii) Explain what a slack value is and identify, from the graph, where slack will occur as a result of the optimum production plan.

9. BETTY CO

Betty Co manufactures children’s scooters and is soon to launch its new MX model with GPS tracking and electronic display, showing the number of miles travelled. Betty Co is yet to decide on a price for the new MX. To reduce the risk of uncertainty, it has commissioned some research on the expected level of demand, based on varying selling price levels. The research suggests that if the price is $400, demand is expected to be 2,000, at $450, demand is expected to be 1,750 and at $500, demand is expected to be 1,500. Variable costs are estimated to be either $120, $160 or $210.

Required:

I. Produce a table showing the expected contribution for each of the nine possible outcomes.

III. Explain the use of expected values and sensitivity analysis and suggest how Betty Co could make use of such techniques.

10. RIN CO

Rin Co manufactures and sells a small range of kitchen equipment. Specifically, the product range contains a dishwasher (DW), a washing machine (WM) and a tumble dryer (TD). The TD is of a rather old design and has for some time generated negative contribution. It is widely expected that in one year’s time the market for this design of TD will cease, as people switch to a washing machine that can also dry clothes after the washing cycle has completed.

Rin Co is trying to decide whether or not to cease the production of TD now or in 12 months’ time when the new combined washing machine/drier will be ready. To help with this decision the following information has been provided:

• The normal selling prices, annual sales volumes and total variable costs for the three products are as follows:

• It is thought that some of the customers that buy a TD also buy a DW and a WM. It is estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.
• All the direct labour force currently working on the TD will be made redundant immediately if TD is ceased now. This would cost $6,000 in redundancy payments. If Rin Co waited for 12 months, the existing labour force would be retained and retrained at a cost of $3,500 to enable them to produce the new washing/drying product. Recruitment and training costs of labour in 12 months’ time would be $1,200 in the event that redundancy takes place now.
• Rin Co operates a just in time (JIT) policy and so all material cost would be saved on the TD for 12 months if TD production ceased now. Equally, the material costs relating to the lost sales on the WM and the DW would also be saved. However, the material supplier has a volume-based discount scheme in place as follows:

Total annual expenditure                                      ($) Discount

0 – 600,000                                                             0%

600,001 – 800,000                                                        1%

800,001 – 9 00,000                                                       2%

900,001 – 960,000                                                        3%

960,001 and above                                                       5%

Rin Co uses this supplier for all its materials for all the products it manufactures. The figures given above in the cost per unit table for material cost per unit are net of any discount Rin Co already qualifies for.

• The space in the factory currently used for the TD will be sublet for 12 months on a short-term lease contract if production of TD stops now. The income from that contract will be $12,000.
• The supervisor (currently classed as an overhead) supervises the production of all three products spending approximately 20% of his time on the TD production. He would continue to be fully employed if the TD ceases to be produced now.

Required:

A. Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12 months (ignore any adjustment to allow for the time value of money).

B. Explain two pricing strategies that could be used to improve the financial position of the business in the next 12 months assuming that the TD continues to be made in that period.

C. Briefly describe three issues that Rin Co should consider if it decides to outsource the manufacture of one of its future products.

11. PP CO

PP Co is a pharmaceutical company which researches, develops and manufactures a wide range of drugs. One of these drugs, ‘Parapain’, is a pain relief drug used for the treatment of headaches and until last month PP Co had a patent on Parapain which prevented other companies from manufacturing it. The patent has now expired, and several competitors have already entered the market with similar versions of Parapain, which are made using the same active ingredients.

PP Co is reviewing its pricing policy in light of the changing market. It has carried out some market research in an attempt to establish an optimum price for Parapain. The research has established that for every $2 decrease in price, demand would be expected to increase by 5,000 batches, with maximum demand for Parapain being one million batches.

Each batch of Parapain is currently made using the following materials:

Material Z:    500 grams at $0.10 per gram

Material Y:    300 grams at $0.50 per gram

Each batch of Parapain requires 20 minutes of machine time to make and the variable running costs for machine time are $6 per hour. The fixed production overhead cost is expected to be $2 per batch for the period, based on a budgeted production level of 250,000 batches.

The skilled workers who have been working on Parapain until now are being moved onto the production of PP Co’s new and unique anti-malaria drug which cost millions of dollars to develop. PP Co has obtained a patent for this revolutionary drug, and it is expected to save millions of lives. No other similar drug exists and, whilst demand levels are unknown, the launch of the drug is eagerly anticipated all over the world.

Agency staff, who are completely new to the production of Parapain and cost $18 per hour, will be brought in to produce Parapain for the foreseeable future. Experience has shown there will be a significant learning curve involved in making Parapain as it is extremely difficult to handle. The first batch of Parapain made using one of the agency workers took 5 hours to make. However, it is believed that an 80% learning curve exists, in relation to production of the drug, and this will continue until the first 1,000 batches have been completed.

PP Co’s management has said that any pricing decisions about Parapain should be based on the time it takes to make the 1,000th batch of the drug.

Note: The learning co-efficient, b = –0.321928

 Required:

A. Calculate the optimum (profit-maximising) selling price for Parapain and the resulting annual profit which PP Co will make from charging this price.

Note: if P = a – bQ, then MR = a – 2Bq

B. Discuss and recommend whether market penetration or market skimming would be the most suitable pricing strategy for PP Co when launching the new anti-malaria drug.

12. BURGLAR CO

Burglar Co manufactures control panels for burglar alarms, a very profitable product. Every product comes with a one-year warranty offering free repairs if any faults arise in this period.

It currently produces and sells 80,000 units per annum, with production of them being restricted by the short supply of labour. Each control panel includes two main components – one keypad and one display screen. At present, Burglar Co manufactures both of these components in-house. However, the company is currently considering outsourcing the production of keypads and/or display screens. A newly established company based in Houston is keen to secure a place in the market, and has offered to supply the keypads for the equivalent of $4.10 per unit and the display screens for the equivalent of $4.30 per unit. This price has been guaranteed for two years.

The current total annual costs of producing the keypads and the display screens are:

Keypads                        Display screens

Production                                                                       80,000 units                       80,000 units

$’000                                    $’000

Direct materials                                                                     160                                       116

Direct labour                                                                           40                                         60

Heat and power costs                                                            64                                         88

Machine costs                                                                         26                                         30

Depreciation and insurance costs                                       84                                         96

Total annual production costs                                            374                                       390

Notes

• Materials costs for keypads are expected to increase by 5% in six months’ time; materials costs for display screens are only expected to increase by 2%, but with immediate effect.
• Direct labour costs are purely variable and not expected to change over the next year.
• Heat and power costs include an apportionment of the general factory overhead for heat and power as well as the costs of heat and power directly used for the production of keypads and display screens. The general apportionment included is calculated using 50% of the direct labour cost for each component and would be incurred irrespective of whether the components are manufactured in-house or not.
• Machine costs are semi-variable; the variable element relates to set-up costs, which are based upon the number of batches made. The keypads’ machine has fixed costs of $4,000 per annum and the display screens’ machine has fixed costs of $6,000 per annum. Whilst both components are currently made in batches of 500, this would need to change, with immediate effect, to batches of 400.
• 60% of depreciation and insurance costs relate to an apportionment of the general factory depreciation and insurance costs; the remaining 40% is specific to the manufacture of keypads and display screens.

Required:

A. Advise Burglar Co whether it should continue to manufacture the keypads and display screens in-house or whether it should outsource their manufacture to the supplier in Houston, assuming it continues to adopt a policy to limit manufacture and sales to 80,000 control panels in the coming year.

B. Burglar Co takes 0.5 labour hours to produce a keypad and 0.75 labour hours to produce a display screen. Labour hours are restricted to 100,000 hours and labour is paid at $1 per hour. Burglar Co wishes to increase its supply to 100,000 control panels (i.e., 100,000 each of keypads and display screens).

Advise Burglar Co as to how many units of keypads and display panels they should either manufacture and/or outsource in order to minimise their costs.

C. Discuss the non-financial factors that Burglar Co should consider when making a decision about outsourcing the manufacture of keypads and display screens.

13. CC CO

CC Co, a company in the civil engineering industry with headquarters located 22 miles from London undertakes contracts anywhere in the United Kingdom.

CC Co has had its tender for a job in north-east England accepted at $288,000 and work is due to begin in March 20X3. However, CC Co has also been asked to undertake a contract on the south coast of England. The price offered for this contract is $352,000. Both of the contracts cannot be taken simultaneously because of constraints on staff site management personnel and on plant available. An escape clause enables CC Co to withdraw from the contract in the north-east, provided notice is given before the end of November and an agreed penalty of $28,000 is paid.

The following estimates have been submitted by CC Co’s quantity surveyor:

Cost estimates

• X, Y and Z are three building materials. Material X is not in common use and would not realize much money if re-sold; however, it could be used on other contracts but only as a substitute for another material currently quoted at 10% less than the original cost of X. The price of Y, a material in common use, has doubled since it was purchased; its net realisable value if re-sold would be its new price less 15% to cover disposal costs. Alternatively, it could be kept for use on other contracts in the following financial year.
• With the construction industry not yet recovered from the recent recession, CC Co is confident that manual labour, both skilled and unskilled, could be hired locally on a sub-contracting basis to meet the needs of each of the contracts.
• The plant which would be needed for the south coast contract has been owned for some years and $12,800 is the year’s depreciation on a straight-line basis. If the north-east contract is undertaken, less plant will be required but the surplus plant will be hired out for the period of the contract at a rental of $6,000.
• It is the company’s policy to charge all contracts with notional interest at 8% on estimated working capital involved in contracts. Progress payments would be receivable from the contractee.
• Salaries and general costs of operating the small headquarters amount to about $108,000 each year. There are usually ten contracts being supervised at the same time.
• Each of the two contracts is expected to last from March 20X3 to February 20X4 which, coincidentally, is the company’s financial year.
• Site management is treated as a fixed cost.

Required:

As the management accountant to the company present comparative statements to show the net benefit to the company of undertaking the more advantageous of the two contracts.

Explain why you have included, or not, each of the items given in the data in your comparative financial statements.

14. FITNESS CO

Fitness Co manufactures three types of fitness equipment: treadmills (T), cross trainers (C) and rowing machines (R). The budgeted sales prices and volumes for the next year are as follows:

T                                C                                R

Selling price                              $1,600                      $1,800                      $1,400

Units                                             420                            400                           380

The standard cost card for each product is shown below.

T                                C                                R

$                                $                                $

Material                                       430                            500                           360

Labour                                          220                           240                            190

Variable overheads                    110                           120                             95

Labour costs are 60% fixed and 40% variable. General fixed overheads excluding any fixed labour costs are expected to be $55,000 for the next year.

Required:

A. Calculate the weighted average contribution to sales ratio for Fitness Co.

B. Calculate the margin of safety in $ revenue for Fitness Co.

C. A chart has been drawn assuming that the products are sold in a constant mix. State the type of chart shown, the axis labels and point A, length B, length C, line D, line E and line F.

D. Explain what would happen to the breakeven point if the products were sold in order of the most profitable products first.

E. Explain the limitations of cost volume profit (CVP) analysis.