Brunswick Plastics, located in Canada, is an injection molding company. Brunswick Plastics produces 50 different products; however, they are not reaching capacity. Production required multiple labor hours, and since they weren’t at capacity, they were finishing a little above breakeven. The Division Manager of Brunswick Plastics, Michael Smith was informed of an opportunity for his company and must make a decision on whether or not to venture into this opportunity. Mr. Smith was informed of a project of producing 150,000 milk crates.
He can place a bid for the project. However, Mr. Smith isn’t confident in the information that he has, and needs answers to best estimate the costs of producing the additional units. The costs that he knows are as follows:
Loading Labor 0.02
Crate Materials 1.71
Stamp Materials 0.04
TOTAL$1.91 per unit
Stamping Machine $5,000 one-time cost
Mr. Smith must make a critical pricing decision to have a competitive advantage in the bid process. He has specific questions which answered, will provide a confident grasp on the situation to enable him to make a decision on whether to place the bid and at what price.
If the bid is too high, it will most likely be rejected, and the company would lose the opportunity to reach capacity and make a higher profit. But, if the bid is too low it would cause a loss for the company. We will answer Mr. Smith’s questions throughout this case analysis.
Question #1: Based on your interpretation of Exhibit 3, what is your estimate of the change in “PFMOH” cost if the factory were to run one extra batch of 150,000 milk crates? Based on the interpretation of Exhibit 3, the linear regression that has the most accurate relationship with Plant Fixed Manufacturing Overhead (PFMOH) is Direct Labor Hours (DLH).
Michael Smith calculated that 3,472 scheduled machine hours would be need, 2,083 running
hours. Using the equation, PFMOH=4321+(2.85*DLH), and knowing that an operator must be present for each hour of scheduled machine hours (3,472), we can determine an increase of $14,216.20. We must also factor in depreciation expense (straight line depreciation) of $500 annually ($5,000/10years). Yielding a change of $14,716.20. 4,321+(2.85*3,472)=$14,216.20
Question #2: What is your estimate of the incremental cost per unit for one batch of 150,000 milk crates?
The incremental cost per unit is $2.09 and is determined by adding the direct labor and direct materials per unit to the variable overhead. Variable overhead is determined by multiplying the number of machine hours by the “rule of thumb” for variable overhead, which is stated in the case as $13 per machine hour of “running time,” and dividing the product by the number of units. ($13*2,083)/150,000=$0.18
Question #3: What does Exhibit 2 suggest would be a “normal” price for milk crates for an “average” job shop? What does this suggest about the $3.00 price which seems to prevail at the time of the case?
The case suggests the price for the crates for an average job shop is:
Therefore, the direct materials and direct labor is $256,500, $1.71 per unit for the average job shop. At $1.71 per unit, Brunswick’s bid price will be much higher at $3.00, which increases the chance that the bid will be rejected. Question #4: What is the “strategically relevant” cost per unit for milk crates? (for purposes of deciding whether or not the $3.00 “market price” is profitable, on an ongoing basis)
At $3.00 market price, producing the 150,000 crates would be profitable for Brunswick, because the profit per unit is $0.81.
Loading Labor 0.02
Crate Materials 1.71
Stamp Materials 0.04
Variable Overhead 0.18
TOTAL COST$2.19 per unit
At $0.81 a unit for 150,000 units, Brunswick’s annual profit would be $121,500.
Question #5: What is your advice to Mr. Smith regarding the milk crate opportunity? Be specific and show the calculation supporting your advice. Assuming the original fixed costs will not be changed, we would recommend that Mr. Smith place the bid for the project. A price of $3.00 is the average current market price; however, considering Mr. Smith’s need for the contract to alter his contribution margin and to meet capacity, we recommend him bidding at $2.90. His opportunity cost of not getting the bid is greater than the $0.10 he will lose if he made a bid at $2.90.The chances are fair for Mr. Smith’s bid to be accepted at this price. If it is accepted, Brunswick would increase their profit by $106,500 annually. They would also come much closer to meeting capacity if they placed the bid.
$2.90 Market Price per unit-$2.19 Total Cost per unit= $0.71*150,000 units=$106,500 of profit
Question #6: What overall strategic advice do you have for Mr. Smith? What isn’t the business doing better, given the new “specialties strategy” and good business conditions? Support your answer with relevant cost analysis.
Based on details within the case, Mr. Smith is obviously bidding jobs too high and not allowing his plant to increase its volume and obtain full capacity. We would advise Mr. Smith to get a better understanding of his costs in order to price his jobs more competitively. Take this project for example, if the incremental cost of this milk crate project is $2.09 and he is certain he can win the bid at $2.90, then that $0.81 of revenue can contribute to 55% of the SG&A costs for the year, from a project that is only 25% of Brunswick Plastics annual sales revenue. Additionally, the case states that a successful bid would give Brunswick a competitive advantage in future orders. Therefore, if they won the other half of the milk crate orders, it would further cover their fixed overhead and not hinder the capacity requirements of the other products Brunswick produces. $0.81*150,000=$121,500/$220,000=.55 or 55%
Considering the calculations we have made, we recommend that Michael Smith place a bid on behalf of Brunswick Plastics for the 150,000 milk crate project at $2.90. It will be wise for Mr. Smith to come in at the lowest market price to dramatically increase the chances of his bid being accepted. Brunswick needs to win this bid so that they may be able to better their contribution margin and come closer to meeting capacity. A win will also increase profit, so they are much higher above breakeven. This could lead to further business with the Dairy Counsel as well.