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Specialty Mouldings Limited (SML) manufactures wood mouldings in rural Cape Breton. SML is the largest employer in the area and many of the retailers and service providers in the area are dependent on the wages paid by SML. Direct Materials and Direct Labour are the only variable costs of production. The mouldings that SML produces are currently sold to building contractors and other retailers through a 10 person sales force that are paid $15,000 per year each, plus a 10% commission. Each linear foot of moulding sells for $0.90. SML’s management prepared the following budgeted income statement for 2017.
Sales 14,250,000 linear feet $ 12,825,000
Cost of Goods Sold:
Direct Materials $2,850,000
Direct Labour $4,275,000
Fixed Manufacturing Overhead 1,400,000
Total Cost of Goods Sold $ 8,525,000
Gross Profit $ 4,300,000
Selling and Admin Expenses:
Sales Salaries and Commissions $ 1,432,500
General and Administrative 1,600,000
Total Fixed Expenses $ 3,432,500
Operating Income $ 867,500
1. Since the completion of the above budget, SML’s management has learned that the its suppliers of lumber (direct material) are demanding a 3% increase in the price SML pays for lumber. The 3% increase applies to all of the direct materials.
2. The HR department disagrees with the budget for labour costs and believes that SML must increase its wage rate by 5% or many of the employees will quit and move “out west”. The 5% increase applies to the direct labour workers only. Sales commissions, sales salaries and other general an administration salaries are expected to remain at budgeted amounts.
3. SML has the option of acquiring a new production machine at an annual leasecost of $1,000,000 plus a fixed annual maintenance contract cost of $175,000. This new machine would reduce the number of factory workers by 25% with a corresponding reduction in the direct labour cost. There would be no impact on the sales personnel or general and administrative personnel.
4. The marketing department believes that sales (both in volume and dollars) will remain at least the same for the next few years. Although there is rumour of a new housing development that could increase sales by an additional 650,000 to 900,000 linear feet of moulding per year. This increase is within the fixed capacity of SML’s production facilities.
Required (Parts 1 through 4 must be done in excel)
1. Assuming sales of $12,825,000, construct a budgeted contribution format income statement for the upcoming year for each of the following alternatives. Your statement must be in good form and include dollars per unit, dollars in total, and ratios
a) No change in workers’ salaries or direct material costs – same assumptions as the original budget presented above
b) An increase in material costs and wages as per the Additional Information above
c) The increase in material costs and wages (as per part (b)) as well as the introduction of the new machine as described in the additional Information, Point 3 above.
2. Calculate GC’s break-even point in linear feet for the upcoming year for each of the alternatives noted in Part 1. Show your formula.
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3. To meet the expectations of the owners, GC must achieve an operating income of $550,000 per year. Calculate the sales (in dollars) required to achieve and operating income of $550,000 for each of the alternatives. Show your formula.
4. Determine the volume of sales at which operating income would be equal regardless of whether GC continues with its current work force (at the new wage rate) or acquires the new production machine. Provide proof for your answer. (Note: assume that the increases noted in Additional Information 1. and 2. apply in either case.)
5. Write a memo (150 to 400 words) to the president of GC in which you recommend whether the company should continue to use its current workforce (at the new higher rate) or acquire the new production machine. Your memo should reference the point of indifference and consider any ethical or human resource issues with regards to your recommendation
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