The company’s variable manufacturing cost (including direct materials, direct labor, and variable manufacturing overhead) is $5 per unit. Fixed manufacturing ov
Stars, Inc. is a manufacturing company that has made toys for children for three years. The CEO Mr. Jones is
very frustrated with the company’s performance and has hired Mr. Kaye as the company’s new accountant. Mr.
Jones provides the following information to Mr. Kaye.
Year 1 Year 2 Year 3
Sales in units 60,000 40,000 40,000
Production in units 60,000 50,000 60,000
Price $ 10 10 10
The company’s variable
administrative expense is $1 per unit and the fixed selling and administrative expense is $100,000 per year. The
company uses the LIFO (last-in first-out) inventory flow assumption that the newest units in inventory are sold
first.
After reviewing all information provided, Mr. Kaye prepared one income statement for Mr. Jones, with the
purpose of discovering the existing problems within the company and gathering information for future decision
making.
Mr. Jones also considers improving the production efficiency of his company. He realizes if he rents a new
equipment, the production costs will be reduced. He then gathers the following information:
The new equipment can be rented at a cost of $60,000 a year. To operate the new equipment, the company also
needs to hire a supervisor whose annual salary is $40,000. The equipment will reduce the direct materials cost
and direct labor cost by 50%. Currently, direct materials, director labor, and variable manufacturing overhead
cost $2, $2, and $1, respectively. Mr. Jones further finds that the use of new equipment has no impact on the
company’s fixed manufacturing overhead.
Required:
Mr. Jones is not sure whether it is worthwhile to rent the new equipment. Mr. Kaye shows his prediction of the
next three years’ sales. In Year 4, Year 5, and Year 6, the predicted sales units are 40,000, 50,000, and 60,000,
respectively. Please make your recommendations to Mr. Jones, in which year should the company rent the new
equipment?
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