Ringo Rag Company The weighted revenue per cwt is lowest for junk since

Ringo Rag Company

Teaching Commentary

OVERVIEW

This case was developed for use in an introductory-level MBA course on managerial accounting. The case teaches very

well if used early in the term, after the students have been exposed to basic cost concepts such as fixed and variable

costs, contribution margin, and full cost profit. The case is complex enough to support two class periods (ninety minutes

TEACHING STRATEGY

If the case is used for one class period, the instructor has to keep the discussion moving at a rapid pace to cover all the

issues. The following teaching questions (with approximate time allocations) are designed to facilitate a discussion of

the case when used for one class period (ninety minutes):

2. Profitability calculations by raw material source. These calculations can be difficult for students but it is important

that the instructor develop these numbers using student volunteers. We suggest that a maximum of 40 minutes be

devoted to coming up with something similar to Exhibit 1. Managing class time can be difficult in this part. The

3. Managerial implications for optimal sourcing. Here, we develop the intuition for an LP model but do not actually do

one (fifteen minutes).

6. Wrap-up and summarize the managerial issues (five

minutes):

a. Raw material sourcing

SUGGESTED ANSWERS TO ASSIGNMENT

QUESTIONS

Calculation of Profitability by Raw Material Source

1. Manufacturing process

2. Average revenue per pound, by grade

A $7,750/50k = .155

3. Weighted average revenue per cwt sold, for each

source

NOTES:

a. The weighted revenue per cwt is lowest for junk

since junk yields low levels of Grade A relative

to other raw material sources.

C $4.00/cwt ÷ .8 yield = $5.00/cwt

NOTES:

a. The revenue numbers shown above are for units

of yielded output (i.e., per lb sold). To compare

costs with revenues, the costs are also calculated

based on yielded output.

a. Grading 1,000 hrs x $1.10 = $1,100

Quantity graded =110,000 lb

∆ Cost/cwt =$1.00/cwt

b. Cutting 3,000 hrs x $1.10 = $3,300

Quantity cut = 162,500 lb

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7. Variable overhead (Wash/Dry Only)

Annual: Gas $600

8. Electricity for cutting is trivial (<$.01/cwt). Ignore it.

9. Production Fixed Overhead

a. Foreman = $15,000/yr = $1,250/month

OR, if treat foremen as general overhead:

Overhead = $17,200

+15,000 =$32,200

One can reasonably infer that they are grossly overpaid

since their time should be paid at a rate about 1.3 times

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Exhibit 1

Profitability by Source

Yielded Pounds Basis (100 pounds)

Junk Laundry Tex-A Tex-B Tex-C

REVENUE 13.30 13.50 15.50 13.00 12.50

Volume Dependent Costs

*Rank order

USING A DIFFERENT ALLOCATION RULE FOR FOREMEN (TREAT THEM AS A COMMON COST)

Allocated Fixed OH

Inferences for Sourcing Strategy?

Exhibit 2

Contribution Margin By Grade

A B C

Ranked by Declining Profit Ranking

First J J T

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of two laborers’ time to junk only as follows:

$1.10hr x 40hrs/wk x 52 wk/yr x 2 laborers= ~$4,500

After getting a reasonable agreement on Exhibit

1, the interesting question is, so what? Are there any

management implications for sourcing raw materials?

Where should management go for raw material? As a

first pass, the following inferences can be drawn based on

Exhibit 1:

rely exclusively on a single raw material source to satisfy

the specific demand for all three grades.

SOURCING STRATEGY—USING

CONTRIBUTIONS

Students should argue that the junk source

should be fully exploited in the short run since it has the

highest contribution per unit.

(1) Fill up W/D (Junk source). We are currently running

the W/D at 50,000/mo.

(Exhibit 2).

But, if buy some from Laundry, we will get some A

A (1/4) = 430

B (1/2) = 860

C (1/4) = 430

But remember that long run, J is not as good as any

of the other four sources!

We definitely need a linear program to find an optimal

solution here.

raw material sourcing decision as purely a short–term

decision (in which case the contribution approach can be

justified) or as a long-term policy issue (which would

then argue for the full cost approach).

As is shown in Exhibit 1, the recommended

purchasing policies will differ dramatically depending on

whether the objective function maximizes contribution or

full cost profit. What should management do? Students

should realize that eliminating the junk source completely

would increase the relative power of the remaining two

suppliers — textile converters and laundries. This is

especially true since these two supplier groups have the

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from textile converters are joint across the three grades, so

that profit by grade is essentially a meaningless exercise!

35,000 (T) (70%) 11.05 7.74

50,000 Total 10.52

Rev 15.50

– VC 10.52

= Contribution Margin 4.98

Useful Somehow?

Optimal Shipping Quantity

Regarding shipping quantity, there is a dramatic

price cut per pound as the carton size increases. Consider

the following table:

Price per Pound by Carton Size

Price of

5 lb container

variations in packing costs could not explain variations in

prices across package sizes. One inference based on this

analysis is that profitability per pound declines sharply as

Manufacturing Process Changes

Should the firm drop the grading process

altogether and sell all junk as Grade C? At first pass, one

might conclude that it is desirable to drop grading, as the

following analysis shows:

discontinue grading.

Since the total demand for Grade C is only 250

cwt., we would scale back washer/dryer usage to 50,000

pounds. All Grades A and B would have to be supplied

only from textiles since we have decided not to grade junk

or laundry and sell them only as Grade C. The variable

cost for this option is as follows:

Grade A = Textile A = 11.05 (vs. 1/3J + 2/3L = 1/3 8.71 +

2/3 9.55 = 9.26)

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the cutting labor would go up. Note further that cutting

labor per cwt is higher than grading labor (Exhibit 1):

Cutting-now = $3.05 (.67 yield)

Overall Economics of the Business

The last assignment question asks the student to

consider whether this business is in serious need of help

“frosting on the cake”

II. A profitable firm, but Ford Motor Johnson &

one that could do Johnson

better. But, it is more

profitable than most

firms.

forces analysis, all indications are that this should not be a

good business. All the five forces are unfavorable for the

rag dealers.

1. Supplier power in this industry is high:

3. Threat of substitutes is high from paper products,

which are low cost.

4. Entry barriers are low:

a. Low technology;

Why then is Ringo Rag such a lucrative

business? Why have more competitors not been attracted

to this market to compete away these “excess returns”?

The reasons appear to lie in the low public profile of the

industry and the unappealing nature of the work. It seems

unlikely that an MBA at a tenth- year reunion would want

to admit to being in the rags business when classmates are

Exhibit 3

Overall Economics of Ringo Rag Company

INCOME STATEMENT FOR THE YEAR

Sales of $17,375 x 12 months $ 208,500

Costs:

Raw Material for one month:

Junk 500 cwt x $1 = $ 500

Laundry 600 cwt x $3 = 1,800

162,660

Profit before tax $ 45,840

Tax (~ 25% then) 11,460

PROFIT AFTER TAXES $ 34,380

Estimated Investment

Working Capital:

1) Cash (estimated) (Just enough to keep the bank account open) $ 1,000

2) Inventory (see Note 1):

Equipment:

Washer/Dryer (760 x fiveyear life) $ 3,800

Cutting equipment (300 x 1ten-year life) 3,000