Concept explainers
NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past 3 years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra that it produces each year. As a result, NoFat’s controller, Allyson Ashley, has decided to seek out potential special sales offers from other companies. One company, Patterson Union (PU)—a toxic waste cleanup company—offered to buy 10,000 pounds of olestra from NoFat during December for a price of $2.20 per pound. PU discovered through its research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund Sites by the U.S. Environmental Protection Agency. Allyson was excited, noting that “This is another way to use our expensive olestra plant!”
The annual costs incurred by NoFat to produce and sell 100,000 pounds of olestra are as follows:
In addition, Allyson met with several of NoFat’s key production managers and discovered the following information:
- The special order could be produced without incurring any additional marketing or customer service costs.
- NoFat owns the aging plant facility that it uses to manufacture olestra.
- NoFat incurs costs to set up and clean its machines for each production run, or batch, of olestra that it produces. The total setup costs shown in the previous table represent the production of 20 batches during the year.
- NoFat leases its plant machinery. The lease agreement is negotiated and signed on the first day of each year. NoFat currently leases enough machinery to produce 125,000 pounds of olestra.
- PU requires that an independent quality team inspects any facility from which it makes purchases. The terms of the special sales offer would require NoFat to bear the $1,000 cost of the inspection team.
Assume for this question that Allyson’s relevant analysis reveals that NoFat would earn a positive relevant profit of $10,000 from the special sale (i.e., the special sales alternative). However, after conducting this traditional, short-term relevant analysis, Allyson wonders whether it might be more profitable over the long term to downsize the company by reducing its manufacturing capacity (i.e., its plant machinery and plant facility). She is aware that downsizing requires a multiyear time horizon because companies usually cannot increase or decrease fixed plant assets every year. Therefore, Allyson has decided to use a 5-year time horizon in her long-term decision analysis. She has identified the following information regarding capacity downsizing (i.e., the downsizing alternative):
- The plant facility consists of several buildings. If it chooses to downsize its capacity, NoFat can immediately sell one of the buildings to an adjacent business for $30,000.
- If it chooses to downsize its capacity, NoFat’s annual lease cost for plant machinery will decrease to $9,000.
Therefore, Allyson must choose between these two alternatives: Accept the special sales offer each year and earn a $10,000 relevant profit for each of the next 5 years or reject the special sales offer and downsize as described above.
Assume that NoFat pays for all costs with cash. Also, assume a 10% discount rate, a 5-year time horizon, and all
- a. Calculate the NPV of accepting the special sale with the assumed positive relevant profit of $10,000 per year (i.e., the special sales alternative).
- b. Calculate the NPV of downsizing capacity as previously described (i.e., the downsizing alternative).
- c. Based on the NPV of Requirements 5a and 5b, identify and explain which of these two alternatives is best for NoFat to pursue in the long term.
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Chapter 12 Solutions
Managerial Accounting: The Cornerstone of Business Decision-Making
- NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past 3 years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra that it produces each year. As a result, NoFats controller, Allyson Ashley, has decided to seek out potential special sales offers from other companies. One company, Patterson Union (PU)a toxic waste cleanup companyoffered to buy 10,000 pounds of olestra from NoFat during December for a price of 2.20 per pound. PU discovered through its research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund Sites by the U.S. Environmental Protection Agency. Allyson was excited, noting that This is another way to use our expensive olestra plant! The annual costs incurred by NoFat to produce and sell 100,000 pounds of olestra are as follows: In addition, Allyson met with several of NoFats key production managers and discovered the following information: The special order could be produced without incurring any additional marketing or customer service costs. NoFat owns the aging plant facility that it uses to manufacture olestra. NoFat incurs costs to set up and clean its machines for each production run, or batch, of olestra that it produces. The total setup costs shown in the previous table represent the production of 20 batches during the year. NoFat leases its plant machinery. The lease agreement is negotiated and signed on the first day of each year. NoFat currently leases enough machinery to produce 125,000 pounds of olestra. PU requires that an independent quality team inspects any facility from which it makes purchases. The terms of the special sales offer would require NoFat to bear the 1,000 cost of the inspection team. Based solely on financial factors, explain why NoFat should accept or reject PUs special sales offer.arrow_forwardNoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past 3 years, sales of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra that it produces each year. As a result, NoFats controller, Allyson Ashley, has decided to seek out potential special sales offers from other companies. One company, Patterson Union (PU)a toxic waste cleanup companyoffered to buy 10,000 pounds of olestra from NoFat during December for a price of 2.20 per pound. PU discovered through its research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund Sites by the U.S. Environmental Protection Agency. Allyson was excited, noting that This is another way to use our expensive olestra plant! The annual costs incurred by NoFat to produce and sell 100,000 pounds of olestra are as follows: In addition, Allyson met with several of NoFats key production managers and discovered the following information: The special order could be produced without incurring any additional marketing or customer service costs. NoFat owns the aging plant facility that it uses to manufacture olestra. NoFat incurs costs to set up and clean its machines for each production run, or batch, of olestra that it produces. The total setup costs shown in the previous table represent the production of 20 batches during the year. NoFat leases its plant machinery. The lease agreement is negotiated and signed on the first day of each year. NoFat currently leases enough machinery to produce 125,000 pounds of olestra. PU requires that an independent quality team inspects any facility from which it makes purchases. The terms of the special sales offer would require NoFat to bear the 1,000 cost of the inspection team. Assume for this question that NoFat rejected PUs special sales offer because the 2.20 price suggested by PU was too low. In response to the rejection, PU asked NoFat to determine the price at which it would be willing to accept the special sales offer. For its regular sales, NoFat sets prices by marking up variable costs by 10%. If Allyson decides to use NoFats 10% markup pricing method to set the price for PUs special sales offer, a. Calculate the price that NoFat would charge PU for each pound of olestra. b. Calculate the relevant profit that NoFat would earn if it set the special sales price by using its markup pricing method. 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- The Cool Can Company manufactures drink koozies and has been approached by a new customer with an offer to purchase 15,000 units at a per-unit price of $7.00. The new customer is geographically separated from Cool Can's other customers, and existing sales will not be affected. Cool Can normally produces 95,000 units but plans to produce and sell only 65,000 in the coming year. The normal sale price is $16 per unit. Unit cost information is as follows: Direct materials Direct labor Variable overhead Fixed overhead. Total In addition, assume that the new customer also wants to have its company logo affixed to each koozie using a label. Cool Can would have to purchase a special logo labeling machine that will cost $12,000 The machine will be able to label the 15,000 units and then it will be scrapped (with no further value). No other fixed overhead activities will be incurred. In addition, each special logo requires additional direct materials of $0.20 $3.10 2.50 1.15 1.00 $8.55…arrow_forwardThe Cool Can Company manufactures drink koozies and has been approached by a new customer with an offer to purchase 15,000 units at a per-unit price of $7.00. The new customer is geographically separated from Cool Can's other customers, and existing sales will not be affected. Cool Can normally produces 82,000 units but plans to produce and sell only 65,000 in the coming year. The normal sales price is $12 per unit. Unit cost information is as follows: Direct materials Direct labor Variable overhead Fixed overhead Total $3.10 1.50 1.00 1.80 $7.40 If Cool Can accepts the order, no fixed manufacturing activities will be affected because there is sufficient excess capacity. Required: Download Excel spreadsheet 1. What are the alternatives for Cool Can? 2. Conceptual Connection: Should Cool Can accept the special order? By how much will operating income increase or decrease if the order is accepted? 3. Conceptual Connection: Briefly explain the significance of the statement in the exercise…arrow_forwardThe Cool Can Company manufactures drink koozies and has been approached by a new customer with an offer to purchase 15,000 units at a per-unit price of $7.00. The new customer is geographically separated from Cool Can's other customers, and existing sales will not be affected. Cool Can normally produces 82,000 units but plans to produce and sell only 65,000 in the coming year. The normal sales price is $12 per unit. Unit cost information is as follows: Direct materials $3.10 Direct labor Variable overhead Fixed overhead Total 1.50 1.00 1.80 $7.40 However, assume that Cool Can plans to produce and sell 70,000 units in the coming year (rather than the originally anticipated 65,000 units). Required: 1. Using Excel (or some other spreadsheet software tool), calculate the amount by which total operating income increases or decreases if the order is accepted. Decrease -84,000 X 2. Conceptual Connection: Should Cool Can accept the special order when sales at the regular price are expected to…arrow_forward
- APQ Company currently sells a piece of equipment for $150 per unit. It plans on lowering the price of the unit to $119 per unit. The cost of goods for each unit is consistent each year, at $52 per unit. The company expects to sell 100,000 units in the current year. Suppose that if APQ drops the price on the equipment immediately, it can increase sales over the next year by 30% to 130,000 units. Will this price decrease have a positive or negative impact on the company's EBIT? What will be the dollar value of the incremental impact of this price drop on the firm's EBIT? Will this have a positive or negative impact on the EBIT for the company? What will the dollar value of the incremental impact of the price drop be for the company? (Enter a negative for a loss, positive for a gain; round your answer to the nearest whole dollar.)arrow_forwardFast Foods Giant (FFG) is a fast food chain and purchases 100,000 pounds of soybean oil per month to fry French fries. FFG typically purchases soybean oil on the local spot market and the company has not entered into any forward purchase contracts for its soybean oil. FFG’s management team has prepared a business plan for the year which assumes $30.00 per pound soybean oil prices. Margins in the fast food business are fairly slim, though, so management is concerned that a significant increase in the price of oil could cause the company to miss its earnings projections. Spot soybean oil prices have been acceptable over the first six months of the year, but management is now concerned about December oil prices. On July 1, management decides it wants to use soybean oil futures contracts to manage its price risk for purchases of soybean oil in December. Assume that FFG’s management has properly documented a cash flow hedge accounting program associated with this risk management activity,…arrow_forwardn Chocolove is a chocolate manufacturer with headquarters and a manufacturing facility in Boulder, Colorado. Assume a three-year scenario during which Chocolove's cost of goods increased by $1 per unit each year from $10 to $11 to $12. It priced its goods to achieve a 50% gross profit per unit (.e. 100% markup). In years 1 and 2, Chocolove buys 1,000 units but sells only 700 units. In year 3, Chocolove buys 700 units, sells 1,300. Assume Chocolove follows LIFO. The profit margin in year 2. and the profit margin in year 3 Select one: O a. 50%; >50% O b. 50%; 50%; > 50% 17arrow_forward
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