Joe Smith has owned and operated Smith's Tool and Die for 40 years. Currently, he is only making one part, RL-5 which is a small electrical relay. He has a 2-year contract to provide 30,000 parts per month to Ford Motor. Unfortunately, Joe got quite sick and his son, Mike, has had to come in and run the business. Mike is disappointed when he finds the following monthly information about the RL-5 part Per unit 30,000 units Sales Price: $ 22.00 660,000 Variable manufacturing costs $ 14.00 420,000 Variable selling costs $ 2.00 60,000 Fixed manufacturing overhead 150,000 Fixed administrative/selling costs 60,000 Operating income (30,000) Smith’s Tool and Die has the capacity to produce 100,000 units of the RL-5 part per month. Mike comes to you to see what can be done about the current losses Smith’s Tool and Die is experiencing. Mike can pay Ford a non-performance fee and sell the assets of the business. The fee is 10% of the sales revenue for one year. Mike has received an offer from Tony who will pay $1,200,000 for the assets. Tony plans to sell what assets he can, demolish the building and build condos on the land. The current net book value of the assets is $200,000. Assume that Smith’s tax rate on the gain is 21%. How much profit/loss will Mike realize if he sells the assets of the business to Tony? Show computations Are there any qualitative issues that you think Mike should consider before selling off the business?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Joe Smith has owned and operated Smith's Tool and Die for 40 years. Currently, he is only making one part, RL-5 which is a small electrical relay. He has a 2-year contract to provide 30,000 parts per month to Ford Motor. Unfortunately, Joe got quite sick and his son, Mike, has had to come in and run the business. Mike is disappointed when he finds the following monthly information about the RL-5 part
|
Per unit |
30,000 units |
|
|
Sales Price: |
$ 22.00 |
660,000 |
|
Variable |
$ 14.00 |
420,000 |
|
Variable selling costs |
$ 2.00 |
60,000 |
|
Fixed manufacturing overhead |
|
150,000 |
|
Fixed administrative/selling costs |
|
60,000 |
|
Operating income |
(30,000) |
Smith’s Tool and Die has the capacity to produce 100,000 units of the RL-5 part per month.
Mike comes to you to see what can be done about the current losses Smith’s Tool and Die is experiencing.
Mike can pay Ford a non-performance fee and sell the assets of the business. The fee is 10% of the sales revenue for one year. Mike has received an offer from Tony who will pay $1,200,000 for the assets. Tony plans to sell what assets he can, demolish the building and build condos on the land. The current net book value of the assets is $200,000. Assume that Smith’s tax rate on the gain is 21%.
How much
Show computations
Are there any qualitative issues that you think Mike should consider before selling off the business?
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