Reference no: EM133205901

The marketing manager, Raj Mehta, picked up the phone to call Susan Ahmed, the company's cost accounting assistant and Raj's personal friend.

Mehta: Hi Susan.  Can you help me understand something that came up at a meeting earlier today?  It was about break-even when we were discussing cost structure.

Ahmed: What's the problem?

Mehta: The president was talking about automating certain parts of the operations and was throwing out different alternatives.

Ahmed: What's new about that?

Mehta: Well, she was saying something about the changes to the cost structure as a result of that, and that our break-even points might change. As the marketing guy, I would like to better understand the implications of all these proposals for me.  How will these potential changes affection my function in the company?  Can we meet tomorrow afternoon about this?  In the meantime, I will provide you with enough details to compute some numbers for me.

Ahmed: Sounds good Raj.  Now you owe me one!

1/ Ahmed's Analysis

Ahmed worked with the following Contribution Margin Income Statement to conduct her analysis:

Contribution Margin Income Statement
Sales revenues (300,000 units)	$78,000,000
Less: Variable Costs
Variable cost of goods sold	35,100,000
Variable selling and administrative expenses	23,400,000
Contribution Margin	$19,500,000
Less: Fixed Costs
Manufacturing	9,560,000
Selling and administrative	2,783,000
Net Income	$7,157,000

2/ Ahmed's Rough Notes

Ahmed also worked with the following rough notes regarding three new proposals being considered:

• Invest in automation in three areas of sales and marketing: (1) order entry, (2) sales administration, (3) sales distribution.  As a result of this proposal, the contribution margin ratio is expected to increase by 8% and annual fixed costs are expected to increase by $9,570,500.
• Invest in automation in three areas of the organization: (1) sales administration, (2) human resources and corporate office, and (3) manufacturing operations.  This move is expected to increase the contribution margin ratio by 11% and simultaneously increase annuls fixed costs by $11,280,000.  The total cost savings will be divided equally between the manufacturing and non-manufacturing functions.
• Invest in an Activity-Based Costing system and a new performance management system, which will increase the annual fixed costs by $1,800,000.  This move will eliminate the need for a total of 33 accounting and administrative clerical staff at an average cost of $32,000 per year per person, and streamline operations.

Required:

Assume the role of Susan Ahmed, and do the following for Raj Mehta:

1. Recreate the preceding contribution margin income statement with additional columns for per-unit amounts and cost percentages (except for fixed costs)
2. Compute the break-even point for the year.
3. Prepare 3 new contribution margin income statements to reflect the three proposals (assuming there is no effect on sales), including the new break-even points. Ensure that the statements contain columns for per-unit amounts and percentages.
4. Draft a short Memo to Raj describing how the three proposals will affect the break-even sales for the company.

PART 3: NET PRESENT VALUE ANALYSIS

Harper Company has been offered a five-year contract to provide component parts for a large manufacturer. The following data relate to the contract:

• Costs and revenues due to the contract would be:

Cost of special equipment	$160,000
Working capital required	$100,000
Relining of the equipment in three years	$30,000
Salvage value of the equipment in five years	$5,000
Annual revenues and costs:
Sales revenue from parts	$750,000
Cost of parts sold	$400,000
Out-of-pocket operating costs (for salaries, shipping, and so forth)	$270,000

• At the end of five years the working capital would be released for use elsewhere in the company.
• Harper Company uses a discount rate of 10%.

Given the above data, should the contract be accepted?

Required:

1. Calculate the annual net cash flows related to the contract
2. Calculate the present value of the annual cash flows, as well as the one-time cash inflows/outflows to determine the Net Present Value of the contract

Conclude as to whether Harper Company should accept the contract, and state your reasoning.