P3_Final_Dowe_Report_2-20-24

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Jun 19, 2024

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Title Page Dominic Financial Decision-Making MBA 620 Richard Works 2/20/2024

Questions: 1. How much of the fixed costs were allocated between the Standard and Deluxe Boxes based on the Lumpsum Analysis Method? Is the CEO correct that the Deluxe Box is not contributing much to company operating profit? Please elaborate on your answer and include evidence from Tab 1 of the Excel workbook. The Lumpsum Analysis established total fixed cost at $156 million dollars per year for both boxes, the Standard box accounted for $120 million, and the Deluxe box accounted for $36 million of the total fixed cost. The Deluxe box profits account for only 12.5% of the total operating profits for all box sales confirming that Deluxe boxes are not currently providing a significant amount to Largo Global Inc. (LGI) operating profit. The operating profit percentages also show that the Standard box produces a 40.90% return vs. 22.81% for the Deluxe box. Thus, LGI’s operating profits are being greatly supplemented by the Standard box returns, this appears to be because of the Standard boxes far higher annual sales and revenue. Also, the efficiency ratios (operating expenses/revenue {Moles & Terry, 2005}) show that the Standard boxes cost structure is more efficient as cost only account for 59.1% of revenue whereas for Deluxe boxes their cost area whopping 77.2% of revenue. The analysis shows that LGI can improve the operating profit percentage of the Deluxe box by increasing revenue while keeping cost the same or by simply cutting cost out all together. 2. The intern suggested splitting the costs, as you have done in the calculations performed in Tab 2, based on sales volumes. Explain the impact of calculation performed in Tab 2. In your discussions, please elaborate on why the answer has changed from the calculations you performed in Tab 1. Also indicate the benefit of accurate costing when trying to improve operating profit margins. By allocating fixed cost based on sales volume a better representation of profitability in relation to resources can be determined. The operating profit for the Standard box remains relatively unchanged at 40.22%, but the Deluxe box operating profits increased from 22.81% to 25.48% as their fixed cost decreased. The portion of sales volume’s convey that although Standard boxes make up 85.71% of sales (also fixed assets), they only deliver a 40.22% profit return. The opposite is true for the Deluxe boxes as they are delivering a 25.48% profit return with only 14.29%

of sales and these results skew the initial analysis revealing a more positive contribution to the company operating profit. The advantage of accurate costing is to determine if Deluxe boxes are generating enough profit to justify their production. For LGI these results confirm that Deluxe boxes are producing a moderate profit and as the fixed cost are already low, revenue can be improved with increasing sales (more units or increased prices) or decreasing cost even further (Davis & Davis, 2011). 3. Based on the calculations in Tab 3 using ABC, comment on the operating profits made for each product. Explain in your report why operating profits have changed under ABC analysis. Also indicate which of the systems – that is the traditional systems (using lumpsum or volume-based cost allocation in Tab 1 and Tab 2) or the ABC systems, (Tab 3) provide the best answers for decision making to improve cost management in order to improve operating profit. ABC costing shows that determining fixed cost allocation based on smaller sets of activities greatly decreases the Deluxe boxes profit percentage. The Standard boxes profit increases to 45.98%, the Deluxe boxes falls all the way to 2.70% because the annual fixed cost rise to $139.16 million using this method. Deluxe boxes require most of the manufacturing overhead which is why the ABC method is the best for determining how to improve profits, ABC corrects misleading overhead allocation while also linking strategic and operational management (Wegmann, 2019). LGI management should use the ABC method to examine why there are such large differences in the amount needed for Deluxe boxes in the maintenance, inspection, and supervision activities. They are non-value-added activities that may be able to be reduced without sacrificing quality, and this should be considered as this can greatly decrease the portion of fixed cost for Deluxe boxes. Using the other traditional systems does not properly allocate fixed cost to the box types, nor does it enable LGI to develop a strategy to decrease

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cost based on the different fixed cost categories. The ABC method in this case is the best option for LGI to improve profits. 4.The sustainability manger is concerned about the Anti-Deluxe Action group’s impact on the company and suggested that materials and process of making the Deluxe Boxes should be changed. As the process of making the Sustainable Deluxe Boxes, will be less intensive, a suggestion is made that the selling price for the Sustainable Deluxe Boxes could be $23 per unit. Discuss whether changing the price to $23 is a viable option for LGI? Provide evidence from the Excel workbook, Tab 4. A price decrease from $28.50 to $23 will be a feasible option if the price decrease can increase sales volume, which traditionally is a correct assumption (Davis & Davis, 2011). With the decrease in price the breakeven quantity is 6.96 million and the breakeven value is $160.04 million. The operating profit for 18 million units at $23 is only 32.01%, if LGI management wants to match the Standard box operating profit (45.98%) at this price they would have to sell at least 22.66 million Sustainable Deluxe units per year. This is a great opportunity to increase LGI revenue as they already sell 18 million Deluxe units per year at $28.50, lower prices should drive demand to sell additional units (Davis & Davis, 2011) beyond 18 million making the Sustainable Deluxe boxes extremely profitable. At a minimum 18 million in sales with a $23.00 price annual revenue is $414 million, thus LGI should make the change to Sustainable Deluxe boxes. 5. If Largo Global Inc. decides to sell the Sustainable Deluxe Boxes at the price the CEO demands to maintain the same profit percentage as for Standard Boxes do you think the new price calculated in Tab 4 is a viable option? Why is it important for LGI to know what their Breakeven quantity is? Also indicate which other (non-numerical information) should be considered when deciding to pursue the Sustainable Deluxe Box option. If LGI management wants the operating profit for Sustainable Deluxe boxes to match that of the Standard (45.98%), then with sales units per year at 18 million the price would have to be $28.95 per box, which would be a price increase that would most likely decrease sales. The breakeven quantity is 4.65 million and the breakeven value is 134.66 million at this price which is key as sales should be expected to decrease, thus management needs to be

aware of the minimum sales required for cost and income to be equal (UMGC, 2022). For the Sustainable Deluxe boxes at the $28.95 price the margin of safety is $386.44 million, which is not guaranteed if sales decrease below 18 million units, but this is still a positive margin. Other factors that must be considered are if the price decrease will make consumers believe that LGI is now selling an inferior product, quality will have to be maintained. The change going forward should be presented to external stakeholders as a customer focused change, that is value-added by transitioning to “green” environmentally friendly manufacturing which has been proven to be a commercially beneficial initiative (Wegmann, 2019). Pursuing reduced cost in unison with reduced prices will make the Sustainable Deluxe box a financial success while also improving customer relations with LGI. References Davis, C. E. & Davis, E. (2011). Managerial Accounting. Wiley. Moles, P., & Terry, N. (2005). efficiency ratio (Banking). The Handbook of International Financial Terms . https://doi- org.ezproxy.umgc.edu/10.1093/acref/9780198294818.013.2551

Wegmann, G. (2019). A Typology of Cost Accounting Practices Based on Activity-Based Costing a Strategic Cost Management Approach. Asia-Pacific Management Accounting Journal, 14(2), 161–184. https://doi- org.ezproxy.umgc.edu/10.24191/apmaj.v14i2-08 University of Maryland Global Campus (UMGC). (2022). Week 5: Project 3 Review and Practice Guide. Document posted in UMGC MBA 620 9042 online classroom, archived at https://learn.umgc.edu

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