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11-44 (continued-1)
2. The net first-year cost savings from closing the plant are estimated as
$7,200 (in thousands), as follows:
The depreciation amounts are not relevant to the decision
because they represent portions of sunk costs that are being
Corporate allocation is not relevant because this represents costs
incurred outside Denver Cover and assigned to the plant.
The cost advantage of outsourcing is predicted to increase in subsequent
years based on the fact that the materials contract cancellation fee and
the employee-assistance programs occur only in year one.
11-44 (continued-2)
current difficult economic times. Will wage rates in the U.S. fall relative to
other countries to make the Denver plant more competitive? If so, then
closing the plant at this time might be unwise, irrespective of the analysis
of costs; the company would then need the plant for future low-cost
production. The analysis of the decision regarding the Denver plant
requires a complex and comprehensive consideration of global economic
trends as well as the costs in the plant itself.
11-45 Sell-or-Process-Further Decision (60-75 min)
1. Schematic Diagram: Two-Stage Process
Note: The problem states that mfg. overhead is entirely fixed; as such, it is
considered a sunk cost with respect to the sell-or-process further decision.
Incremental costs and revenues are reflected in the above diagram.
2. Since the number of processing hours is limited (i.e., is a scarce
resource), the short-term objective would be to maximize the contribution
margin per hour of processing time. Data in this regard for each of the two
products are as follows:
11-45 (Continued-1)
Thus, on a contribution margin per processing hour basis, Process #1
output is more profitable than output from Process #2. Short-run
operating income would be maximized if all available hours were used
to produce Process #1 output.
11-45 (Continued-2)
11-46 Profitability Analysis; Excel (60-75 min)
1. The profit report Hal is using is not contribution-based, so the first step
is to produce a contribution income statement for the three product lines, as
shown below. Note that fixed costs are not allocated to the product lines
since they are irrelevant to the short-term profitability analysis.
The analysis shows that all three lines have a positive contribution margin,
including the Weldon line. The short-term financial effect of dropping the
For example, if sales in the Weldon line are expected to fall and there are
attractive alternative uses of the plant’s capacity, then the Weldon line
might be discontinued now, suffering a short-term loss (as noted above), for
the purpose of securing a longer-term gain.
2. Since the Weldon product has a positive contribution margin of $94.20
per unit, the total contribution margin will be positive irrespective of the
level of sales (other than zero, of course), and the analysis in Part 1 will
continue to favor keeping the line (at least in the short run). However, Hal
and Joan might want to consider alternate uses of the plant facilities if
Weldon sales continue to fall.
11-46 (continued-1)
3. The 10% sales increase has total sales of 165,000 units for Parker and
368,500 units for Virginian. The analysis for dropping Weldon is as follows.
4. Required increase in sales from the Parker line (to compensate
elimination of Weldon line):
Step One: Create the Contribution Income Statement in Part 3 above.
(That spreadsheet occupied B104:I124.) Enter a zero into cell D106 and
335,000 into cell F106. Afterwards, you should see the following:
11-46 (continued-2)
Step Two: Run Goal Seek, as follows(note that the decision cell is cell
D106, sales volume for the Parker Line):
Step Three: Results (see below)
11-46 (continued-3)
The analysis shows that sales in the Parker line would have to increase to
5. HPF competes on the basis of quality and innovation, a differentiation
strategy. The decision about the Weldon line should therefore include how
the line contributes to the firm’s image of quality and innovation. Will the
loss of the line cause HPF’s customers to reduce their perceptions of HPF’s
quality and innovation?
