Acc/504 Week 4

U1-40 (30 min) Benefit-cost analysis—add a project
a. and b. | Income Statement | New contract changes | Dollar impact of new contract | Income with new contract | Sales revenue | $ 1,500,000 | $ 200,000 | $ 200,000 | $ 1,700,000 | Costs | | | | | Labor | 700,000 | 175,000 | 175,000 | 875,000 | Equipment lease | 104,000 | 12% | 12,480 | 116,480 | Rent | 120,000 | - | - | 120,000 | Supplies | 60,000 | 15% | 9,000 | 69,000 | Officers' salaries | 400,000 | - | - | 400,000 | Other costs | 50,000 | 15% | 7,500 | 57,500 | Total costs | 1,434,000 | | 203,980 | 1,637,980 | Operating profit (loss) | $ 66,000 | | $ (3,980) | $ 62,020 | Technically, the new contract reduces profit of the company by $3,980. By itself, this one-year contract appears not to be worth the effort of hiring and training new, part-time consultants.
c. Other considerations include (1) whether this will
enable the company to get into a new, profitable line of business, (2) what other opportunities the company has for expansion, (3) whether the contract will provide for more revenues in the future, and (4) what obligations the company makes to its employees. In short, the company should consider both short and long run costs and benefits of its decisions.
SOLUTIONS TO CASES 1-41 (40 min) Analyze strategic decision a. The following spreadsheet computes customer profitability. If the lower portion of the spreadsheet (rows 8 – 17) contains only formulas, you can test the sensitivity of the profit estimates to changes in the parameters (rows 2 – 7). | A | B | C | 1 | Annual Average Data | Large Customer | Small customer | 2 | Number of orders per year | 2000 | 200 | 3 | Sales value of supplies per order in dollars | $1,000 | $600 | 4 | Cost of supplies to Corporate Express as a percent of sales | 80% | 75% | 5 | Processing cost per order | $25 | $25 | 6 | Delivery cost per order as a percent of sales | 8% | 8% | 7 | Cost to create and maintain Internet access per customer per year | $3,000 | $3,000 | 8 | Annual Customer profitability | | | 9 | Revenues (B2*B3, C2*C3) | $2,000,000 | $120,000 | 10 | Cost of supplies (B4*B9, C4*C9) | 1,600,000 | 90,000 | 11 | Gross margin (B9-B10, C9-C10) | 400,000 | 30,000 | 12 | Operating costs | | | 13 | Ordering costs (B2*B5, C2*C5) | 50,000 | 5,000 | 14 | Delivery costs (B6*B9, C6*C9) | 160,000 | 9,600 | 15 | Internet access costs (B7, C7) | 3,000 | 3,000 | 16 | Total operating costs (SUM(B13:B15), SUM(C13:C15) | 213,000 | 17,600 | 17 | Customer profit (B11-B16, C11-C16) | $187,000 | $12,400 |

b. Assuming that Corporate Express has constrained order processing capacity, simply displacing one large customer to serve ten small customers would have an adverse impact on profits because Corporate Express would lose $187,000 profit while gaining only 10 x $12,400 = $124,000 profit. Unless Corporate Express feels that these companies will grow to be more profitable than its current average customer, this can be an unwise tradeoff. In fact, Corporate Express has decided to restrict its services to larger companies because it believes smaller companies are unprofitable to serve. c. On average, each small customer would have to increase its profitability from $12,400 to $18,700 by increasing the value of its orders, by paying a premium for services, by demanding less costly service, or a combination of these actions. On the face of it, these might be likely, and if Corporate Express can identify promising new customers, it may be able to design an “introductory” level of service to attract customers that can “grow” into more profitable service.

d. It might be worthwhile for Corporate Express to consider a pilot program with a few, selected companies in order to design and test a new level of service. A limited pilot test will allow the company to investigate and experiment with the costs and benefits of serving small companies without the risk of a full-scale implementation that may be very difficult to change or reverse.

13.55 (30 min) Cost reduction at 200,000 units | This year | Change | Next year | Sales price per unit | $700 | $ (120) | $580 | Product costs per unit | | | | Materials | | | | Computer chip | $77.00 | $ (29.00) | $48.00 | Motor | $60.00 | 0 | 60.00 | Housing unit | $50.00 | -18% | 41.00 | Mechanical parts | $86.00 | 0% | 86.00 | Miscellaneous parts | $22.00 | -18% | 18.04 | Total materials | $295.00 | | $253.04 | Labor | | | | Assembly labor | $90.00 | -20% | 72.00 | Testing labor | 60.00 | -20% | 48.00 | Total labor | $150.00 | | $ 120.00 | Equipment and facilities | | | | Specific to Sergzig | 70.00 | -20% | 56.00 | General administrative | 80.00 | 0 | 80.00 | Total equip & facilities | 150.00 | | 136.00 | Total product costs | 595.00 | | 509.04 | Profit per unit | $ 105.00 | | $ 70.96 | Return on sales | 15.0% | | 12.2% |
a. Advantages include: the long-term contract, which can insulate Sayre from price increases and guarantee quality; reductions in the costs of components, labor and facility costs. Disadvantages include: the long-term contract, which can prevent Sayre from using multiple, competing suppliers. Risks involve the reliability of the supplier; the quality of the cheaper chips; perceived or actual reductions in quality of cheaper components.
b. The analysis shows that Sayre cannot meet its target return on sales with the planned changes.
c. A further price reduction will require significant cost reductions to meet the target return on sales, as follows.

Sales, Units | 200,000 | Sales price per unit | $ 540.00 | Return on sales | 15% | Profit per unit | $ 81.00 | Target cost per unit | $ 459.00 | Total target cost | $91,800,000 | Currently feasible costs | | Product costs per unit | $ 509.04 | Currently feasible costs | $101,808,000 | Cost reduction target | $10,008,000 |

SOLUTIONS TO CASES
13.68 (30 - 40 min) Benefit-cost analysis – Grand Coulee Dam. This might seem an unlikely context for a cost management text, but few projects have the impact on business, communities, and the environment as large dams.
The cited article about Grand Coulee Dam in Washington State is very interesting reading. Benefits and costs have not been borne by the same entities or individuals. Currently some of the adversely affected groups (e.g., Native Americans and sport and commercial fishermen) are working toward reparations of past damages. The impacts on businesses and farms in the region could be immense. The World Bank has been a frequent supporter of these projects, but has been criticized for focusing on benefits while ignoring
costs. a. Based on 70 years of experience with the Grand Coulee Dam, one can expect the following benefits and costs: Benefits | Quantifiable? | Increased crop production……………………………………… | Yes | Increased electrical power……………………………………. | Yes | Economic development……………………………………….. | Yes | Flood protection………………………………………………… | Yes | Flat water recreation and transportation……………………. | Yes | Costs | | Opportunity costs of financiers………………………………. | Yes | Loss of traditional lands, fishing, transportation, culture by native peoples………………………………………………… | Yes to quantity, but not easily for $ value | Loss of livelihood by commercial fishermen………………... | Yes | Loss of sport fishing……………………………………………. | Yes to quantity, but not easily for $ value | Displacement of non-native people, housing, businesses | Yes | Losses by farmers and businesses who do not benefit and have relative disadvantages…………………………….. | Yes to quantity, but not easily for $ value | b. If the experience of Grand Coulee Dam is instructive, one should expect intense lobbying for the project by farmers, businesses, other economic and political interests who stand to benefit most from the project. As it turns out, these were the only parties to the decision making about the Grand Coulee Dam. It’s likely that including the other affected parties, like those that bore most of the uncompensated cost before, will extend the decision making and will raise the cost of the project greatly. Not that this is a bad thing, but large new dam projects will have a much more difficult time gaining approval than before.
c. Each of the categories of predicted benefits and costs should be audited on a more timely basis than was the case for the Grand Coulee Dam.