Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of $3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another $4,500,000. Jacobs is afraid to bring this new equipment to the company president’s attention because he convinced the president to invest $3,000,000 in the machinery last year.
Explain what is relevant and irrelevant to Jacobs’s dilemma. What should he do?
The production manager must prepare an incremental analysis before making any decision.
Relevant information is an important requirement to draft effective decisions associated with the future activities of a business concern. Such information enables an administration to make a purchase or make decisions when an outsourcing alternative is available.
The information associated with the additional cost and double production output is relevant for the business to make necessary decisions.
Also, the cost spent by the business on the old machinery is sunk cost, which has become irrelevant information for the business entity.
Hence, Dan Jacobs, the production manager must prepare a differential analysis to determine the annual operating income between the two machines.
Green Thumb operates a commercial plant nursery, where it propagates plants for garden centers throughout the region. Green Thumb has $5,300,000 in assets. Its yearly fixed costs are $625,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total $1.70. Green Thumb’s volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for $4.00 each. Garden centers then mark them up to sell to the public for $9 to $12, depending on the type of plant.
1. Green Thumb’s owners want to earn an 10% return on the company’s assets. What is Green Thumb’s target full product cost?
2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit?
3. Assume Green Thumb has identified ways to cut its variable costs to $1.55 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?
4. Green Thumb started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Green Thumb does not expect volume to be affected, but it hopes to gain more control over pricing. If Green Thumb has to spend $135,000 this year to advertise and its variable costs continue to be $1.55 per unit, what will its cost-plus price be? Do you think Green Thumb will be able to sell its plants to garden centers at the cost-plus price? Why or why not?
Skiable Acres operates a Rocky Mountain ski resort. The company is planning its lift ticket pricing for the coming ski season. Investors would like to earn a 10% return on investment on the company’s $270,000,000 of assets. The company primarily incurs fixed costs to groom the runs and operate the lifts. Skiable Acres projects fixed costs to be $31,000,000 for the ski season. The resort serves about 725,000 skiers and snowboarders each season. Variable costs are about $8 per guest. Currently, the resort has such a favorable reputation among skiers and snowboarders that it has some control over the lift ticket prices.
1. Would Skiable Acres emphasize target pricing or cost-plus pricing? Why?
2. If other resorts in the area charge $85 per day, what price should Skiable Acres charge?
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