Case Study PPT

Decision making with contribution per limiting factor.

GROUP MEMBERS

ROHIT PANCHAL 1131PANDEY 1132PAPIA 1133AKSHAY 1134

Decision making is a key function of managers which involves choosing between alternatives. There are various types of decisions faced by managers.

examples:a) Make or buy a productb) Accept or reject an orderc) Shutdown or continue operations of a plantd) Introduce a new product or not

Decision making costs:The following are the different types of decision making costs:

TYPE OF COST DEFINITION Relevancy

Outlay cost Costs which involve actual outflow of funds.

Relevant.

Notional cost Costs which do not involve outflow of funds Example: Rent paid on own land.

Relevant.

Opportunity cost Profit foregone by not choosing the next best alternative.

Relevant.

Sunk cost / Historical cost

Costs that are already incurred. Irrelevant.

Limiting factor:

A scarce resource which restricts the output generated or sales volume achieved is called a limiting factor. Limiting factors could be raw material, labor hours, machine hours, money etc. In decisions involving limiting factors contribution approach can be used i.e. contribution per unit of the limiting factor. For instance a unit making multiple products has limited availability of machine hours; the product mix is made based on the contribution per machine hour of the products.

Summary

• The Case Study is about Merrion Products Ltd, which was incorporated and commenced to trade in 20x1.

• Its several shareholders consisted of members of the Carroll family. The business was devoted to the import of a raw material.

• substance which was slightly refined to Irish tastes and sold to various customers around the country.

• There are three member of Carroll family involve in Merrion Co. business.

=> Michael Carroll as a Director in Co. => Una Carroll as a Company Accountant. => Patrick Carroll as a Chief of sales Dept.

• After the success of “A” product. Merrion Ltd decided to introduce new products based on the same raw material but refined in different ways.

• In 2003, product "B" was introduced and product "C" was added the following year.

• In fact demand for all products constantly outstripped production.

• Encouraged by this success of all three products, The product D was introduced based on the same raw material.

• family members concentrated mainly on the administrative and selling side of the business.

Problem in Case

• In 2007political instability in the exporting country resulted in a severe restriction on the availability of this raw material.

• Michael Carroll made direct contact with our usual supplier and he indicated that he will be unable to delivery more than 72,000 Euros of raw materials per quarter until conditions improve and that's not going to be for some time.

• The basic problem, Exporter tells the Michael Carroll is that the material is simply not available in his own country due to the current political situation.

• Michael Carroll enquiries regarding possible alternative suppliers of the same raw material in other countries.

• But during short period no one supplier can fill the gap.

Una Interruption

• I expect that our budgets for the next quarter shall have to be revised - downwards -

• and our profits shall be considerably depressed as a result." She circulated the previously agreed budget.

• It supporting schedules for the forthcoming quarter to participants (Exhibits 1 and 2).

EXHIBIT 1Budget for the quarter ending 31 March 20x7

Euros

Budget sales 200,000

Cost of production 149,500

Gross margin 50,500

Administration expenses 19,900

Distribution expenses 5,700

Sales commission 20,000

Financial expenses 800 46,400

Budgeted Net Profit 4,100

EXHIBIT 2Schedule of Revenue and Production Costs per Product.

Product A B C D

Sales price 20 40 30 20

Direct material (imported) 7 16 13 10

Direct labour and packing 3 4 6 4

Production overhead 4 5 6 5

Budget sales (units) 1,500 2,000 2,000 1,500

NOTE: Production overhead includes both fixed and variable expense. The estimated fixed overhead for the forthcoming quarter amounts to 20,000 euros and has been apportioned to each product on the basis of total anticipated sales revenue for each product.

Michael Carroll accepted that the point was valid. After much discussion all family members agreed

that maximum sales value of each product at current prices

Product Euros

A 60,000

B 88,000

C 63,000

D 40,000

Michael Carroll : I recommend that we produce a minimum of 1,000 units of each product during the forthcoming quarter.Una Carroll : If you feel that there is a single, best way to utilise our production facilities in these circumstances now is the ideal time . let us know.

Requirements1. Prepare a statement showing the most profitable production plan for

Merrion Products Ltd. for the forthcoming quarter. Prepare a detailed profit and loss account to accompany your recommendation. Explain your workings.

2. Calculate the firm's break-even point for the forthcoming quarter. What fundamental assumptions have you made?

3. What is the "opportunity cost", if any, associated with the minimum production of 1,000 units of each product?

4. Assuming it was possible to increase all selling prices by 7 euros per unit without influencing demand, would this price increase effect your analysis. Explain.

SOLUTION. 1 Most Profitable Production Plan

• Merrion Products Ltd. has their budgeted sales as well as production and net profit for the first quarter of year 2007.

• Basic criteria raw material available up to 72000 Euros only; definite limit over the sales; and minimum production of 1000 units for each product.

To draw out the new plan, we start first by identifying profitable production and their priority as well.

Product A B C D

Sales price 20 40 30 20

Direct material (imported) 7 16 13 10

Direct labour and packing 3 4 6 4



Budget sales revenue 30,000 80,000 60,000 30,000

Contribution over each euro of sales 0.300 0.375 0.167 0.050

Profit generated over each euro of imported raw material

0.857 0.938 0.385 0.100

Priority of utilization contribution and imported raw materials

2 1 3 4

The fixed production overhead is estimated to be 20,000 euros and been apportioned to each product based on total anticipated sales revenue for each product. This concludes that the firm has been using “Absorption Costing”

we stop using the absorption costing and impose marginal costing method. For that purpose, we identify and reverse

apportion the fixed production costing as below.

Product A B C D



Production overhead (absorption) 4 5 6 5

Total Production overhead 6,000 10,000 12,000 7,500

Fixed Production overhead 3,000 8,000 6,000 3,000

Production overhead (marginal) 2 1 3 3

Now, we take the new production overhead cost into count and reconstruct the most profitable product table once again. This will increase the level of contribution and utilization of raw material for each of the product line

the same priority of most profitable product

Product A B C D

Sale price 20 40 30 20

Direct Material ( Imported ) 7 16 13 10

Direct labour and packaging 3 4 6 4






1.143 1.188 0.615 0.300


2 1 3 4

Now we construct the new plan. But start with the condition applied by the board of members

we must produce at least 1000 units for each product line.

Product A B C D Total

Sales Price 20 40 30 20 110

Direct Material ( Imported ) 7 16 13 10 46

Direct labour and packaging 3 4 6 4 17

Production overhead 2 1 3 3 9

Sales (units) 1,000 1,000 1,000 1,000 4,000

Sales revenue 20,000 40,000 30,000 20,000 1,10,000

Consumed raw material 7,000 16,000 13,000 10,000 46,000

* We revise the sales of product B to maximum sales value as it is the first most profitable product.

(88000/40 = 2200 units maximum sales) Product A B C D Total

Sales (units) 1,000 2,200 1,000 1,000 5,2000

Sales revenue 20,000 88,000 30,000 20,000 1,58,000

Consumed raw material 7,000 35,200 13,000 10,000 65,200


Sales (units) 1,971 2,200 1,000 1,000 6171

Sales revenue 39420 88,000 30,000 20,000 177420

Consumed raw material 13797 35,200 13,000 10,000 71997

* We revise the sales of product A to the maximum of available raw material resources and it is the second most. (Floor((72000-65200)/7)=971 units additional sales)

Finally, we conclude our findings as in this quarter; buy and consume imported raw material up to 71,997 Euros, we will need to sell 6171 units of products, and over the sales we will make 177,420 Euros. Now we present the final statement together the profit and loss account.

Most Profitable Production Plan


Sales Price 20 40 30 20 110


Direct labour and packaging 3 4 6 4 17

Production overhead 2 1 3 3 9

Sales (units) 1,971 2,200 1,000 1,000 6,171

Cost of sales 23,652 46,200 22,000 17,000 1,08,852

Sales revenue 39420 88,000 30,000 20,000 177420

Profit and Loss Account Statement

Budget sales 177420

Cost of production 108852

Gross margin 68568

Less: Fixed production overhead 20000

48568

Administration expenses 19900

Distribution expenses 5,700

Sales commission 17742

Financial expenses 800 44142

Budgeted Net Profit 4,426

Break even point:

The break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain.

Solution 2. BREAK EVEN POINT Merrion Products Ltd is having multiple product line. Therefore, before calculating the break

even point, we need to assume some criteria such as:

• 1. The price of the each product is constant. This means the product A should not be sold at price 10 Euros to customer A and 20 Euros to customer B. They should be constant either 10 Euros or 20Euros to both customer A and B.

• 2. Cost is linear. When production increases, cost should increase in same

ratio. For example if the product 1000 unit of product D is 17000 Euro, then the 2000 units of its production should cost 34000 Euro whereas it grow in linear, same ratio.

• 3. We assume the sales mix price is same and constant and we use average contribution on them. For example, if 10% of Product A sales drop, then 10% of Product B, Product C, as well as Product D sales must also drop – we assume so to generate the break even.

• 4. The 10% of sales revenue is solid commission and therefore we assume this 10% as our variable cost.

This results to variables cost of every product to rise by 10% and contribution reduces.


Sales Price 20 40 30 20 110

Cost of sales 12 21 22 17 72

contribution 8 19 8 3 38

Contribution (after commission) 6 15 5 1 27

Sales (units) 1,971 2,200 1,000 1,000 6,171

Sales revenue 39,420 88,000 30,000 20,000 177420

Sales weight 22.22% 49.60% 16.91% 11.27% 100.00%

*Fixed cost = Expenses - Commission + Fixed production overhead = 44142-17742+20000 = 46400 Break even point in sales revenue = Fixed cost / Weighted average P/V ratio = 46400 27 / 110 = 189,037 Euros sales Break even point in sales unit = Fixed cost/Weighted average contribution margin per unit =46400/27 =1,719 units of product

OPPORTUNITY COST:

Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative forgone (that is not chosen). It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.

http://en.wikipedia.org/wiki/Mutually_exclusive

Solution 3. OPPORTUNITY COST There is an opportunity for the decision of producing 1000 units for each product line.

Product A B C D TotalSales Price 20 40 30 20 110Direct Material ( Imported ) 7 16 13 10 46Sales (units) 1,971 2,200 1,000 1,000 6,171 Consumed raw material 13797 35,200 13,000 10,000 71997 Sales revenue 39420 88,000 30,000 20,000 177420


Sales Price 20 40 30 20 110


Sales (units) 3,000 2,200 1215 0 6415

Consumed raw material 21,000 35,200 15,795 0 71997

Sales revenue 60,000 88,000 36450 0 184450

If we are not restricted to minimum of 1000 units for each product line:

If we produce minimum of 1000 units for each product line:

Opportunity cost = Sales without minimum 1000 - Sales with minimum 1000

= 184450- 177420 = 7030 Euros

• Conclusion= Merrion Products Ltd forgoes 7030 Euros due to the decision of producing minimum 1000 units per product line. This is their opportunity cost.

Solution 4. INFLUENCE OF PRICE • When the price increases by 7 Euro for each product, this will impact

the analysis. The reason is, we had designed the plan based on most profitable product whereas Product B is first and followed by Product A, C and D.

• Most profitable product refers to products that make the firm earn larger piece of profit by optimizing contribution over each Euro of sales and utilizing usage of imported raw material which very limited in our case.

• Now, when the price is revised, the most profitable product priority changes respectively to be Product A first, and followed by Product B, C, and D. Below is the table to illustrate the situation:

.Product A B C D

Sale price 27 47 37 27

Direct Material ( Imported ) 7 16 13 10

Direct labour and packaging 3 4 6 4


Total variable cost 12 21 22 17

Total contribution 15 26 15 10



2.143 1.625 1.154 1.000


1 2 3 4

THANK YOU

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Case Study PPT