Reference no: EM133041383
Problem - Promotional Products (PP) manufactures and sells electronic accessories such as smart-phone cases, flash drives, etc. PP uses a traditional full absorption costing system for financial reporting and has a risk-adjusted weighted-average cost of capital of 18 percent when making capital investment decisions.
PP recently added a new, proprietary, one-terabyte flash drive key chain called "MegaFlash" to its product line. It has hired a product line manager, Karva Dewan, to manage this new one-terabyte product. Dewan can buy 150,000 to 230,000 of the internal circuit boards from one particular Asian producer for $25 per drive. She then has to incur another $5 per drive to mount the circuit board into the key chain. To purchase more than 230,000 one-terabyte circuit boards, she will need to use a second manufacturer that charges $35 per one-terabyte circuit board. Rather than using LIFO or FIFO, PP uses average cost to value inventories.
To insert the circuit board into the key chain and produce a finished MegaFlash requires fixed manufacturing overhead (leased equipment, plant space, utilities, etc.) of $1,500,000 per year. Karva expects to sell 200,000 one-terabyte key chains per year at the profit maximizing price of $50 per drive to both Internet (Amazon) and brick-and-mortar retailers (Walmart and Target). Ms. Dewan receives a bonus based on the reported profits from MegaFlash, calculated as revenues less fully absorbed cost of goods sold. Fully absorbed cost of goods sold includes both fixed and variable manufacturing costs.
Required -
a. How many units of MegaFlash do you expect Ms. Dewan will produce in the first year if she wishes to maximize her first-year bonus? Support your answer with a rigorous data analysis.
b. Is Dewan's decision in part (a) maximizing Promotional Product's value? Why or why not?
c. Provide two suggestions as to how the owners of PP can change Ms. Dewan's performance measure to better align the owners' interest with that of Ms. Dewan. Describe how each of your suggested changes helps better align the owners' interest with that of Ms. Dewan.
d. Describe any potential problems/pitfalls that might arise in each of your two suggested changes in part (c).