Reference no: EM131812626

Sorrentino Company, which has been in business for one year, manufactures specialty Italian pastas. The pasta products start in the mixing department, where durum flour, eggs, and water are mixed to form dough. The dough is kneaded, rolled flat, and cut into fettucine or lasagna noodles, then dried and packaged.

Paul Gilchrist, controller for Sorrentino Company, is concerned because the company has yet to make a profit. Sales were slow in the first quarter but really picked up by the end of the year. Over the course of the year, 717,500 boxes were sold. Paul is interested in determining how many boxes must be sold to break even. He has begun to determine relevant fixed and variable costs and has accumulated the following per unit data:

Price $0.95 Direct materials 0.35 Direct labor 0.25

He has had more difficulty separating overhead into fixed and variable components. In examining overhead-related activities, Paul has noticed that machine hour appear to be closely correlated with units in that 100 boxes of pasta can be produced per machine hour. Setups are important batch-level activity. Paul also thinks that indirect labor hour may be associated with the overhead expense, but there is no evidence showing the relation. Currently, indirect labor hour is scheduled to be 2000 hours per year. Paul has accumulated the following information on overhead costs, number of setups, machine hours, and indirect labor hours for the past 12 months.

Months	Overhead	Number of Setup	Machine Hour	Indirect Labor Hours
Jan	5700	18	595	155
Feb	4500	6	560	135
Mar	4890	12	575	125
Apr	5500	15	615	200
May	6320	20	680	240
June	5100	10	552	183
July	5532	16	630	205
Aug	5409	12	600	115
Sept	5300	11	635	162
Oct	4950	12	525	145
Nov	5350	14	593	185
Dec	5600	14	615	150

Month Overhead Number of Setups Machine Hours Indirect Labor Hours January $5,700 18 595 155 February 4,500 6 560 135 March 4,890 12 575 125 April 5,500 15 615 200 May 6,320 20 680 240 June 5,100 10 552 183 July 5,532 16 630 205 August 5,409 12 600 115 September 5,300 11 635 162 October 4,950 12 525 145 November 5,350 14 593 185 December 5,600 14 615 150

Selling and administrative expenses, all fixed, amounted to $200,000 last year.

In the second year of operations, Sorrentino Company has decided to expand into the production of sauces to top its pastas. Sauces are also started in the mixing department, using the same equipment. The sauces are mixed, cooked, and packaged into plastic containers. One jar of sauce is priced at $2 and required $0.65 of direct materials and $0.45 of direct labor. 60 jars of sauce can be produced per machine hour. The production manager believes that with careful scheduling, he can keep the total number of setups and total number of indirect labor hours (for both pasta and sauce) to the same number as used last year. The marketing director expects to increase selling expense by $30,000 per year to promote the new product and believes Sorrentino Company can sell three boxes of pasta for every one jar of sauce.

Required: 1. Separate overhead into fixed and variable components using regression analysis. Run seven regressions by using different combinations of three independent variables: number of setups, machine hours, and indirect labor hours. These seven regressions are: a) three simple regressions; b) three multiple regressions using two independent variables; c) multiple regression using all independent variables. Which regression equation is the best? Why? Now, the best regression equation is chosen, use it to answer the following questions: 2. Calculate the number of boxes of pasta which must be sold to break even before the expansion into the production of sauces. 3. Now consider the production of sauces, calculate the break-even number of boxes of pasta and jars of sauce. 4. Suppose that the production manager is wrong and that the number of setups doubles. Calculate the new break-even number of boxes of pasta and jars of sauce. 5. Refer to the original data. Suppose that only 40 jars of sauce can be produced per machine hour and that Sorrentino Company will sell two boxes of pasta for every one jar of sauce. Calculate the new break-even number of boxes of pasta and jars of sauce. 6. Comment on the effects of the shift in sales mix and uncertainty in the cost estimation on the break-even points for Sorrentino Company.