(Prochict line changes) You have been engaged to assist the management of Circle X Farm Products in arriving at certain decisions. Circle X has its home office in Arkansas and leases production facilities in Arkansas, Louisiana, and Missis¬ sippi, which produce a fertilizer spreader designed for residential use. The man¬ agement of Circle X has provided you with a projection of operations for 1998, the forthcoming year, as follows:

The sales price per unit is $50.
Due to the marginal results of operations in Mississippi, Circle X has de¬ cided to cease operations and sell that factory’s machinery and equipment by the end of 1998. Managers expect proceeds from the sale of these assets will exceed the assets’ book values by enough to cover termination costs.
However, Circle X would like to continue serving its customers in that area if it is economically feasible and is considering one of the following three alternatives: 1. Expand the operations of the Louisiana factory by using space presently idle. This move would result in the following changes in that factory’s operations:

Under this proposal, variable costs would be $16 per unit sold. 2. Enter into a long-term contract with a competitor who will serve that area’s customers. This competitor would pay Circle X a royalty of $8 per unit based on an estimate of 30,000 units being sold. 3. Close the Mississippi factory and not expand the operations of the Louisiana factory.

To assist the management of Circle X Farm Products in determining which alternative is more economically feasible, prepare a schedule computing Circle X’s estimated pretax profit from total operations that would result from each of the following methods:

a. Expansion of the Louisiana factory.

b. Negotiation of a long-term contract on a royalty basis.

c. Shutdown of the Mississippi operations with no expansion at other locations. Note: Total home office costs of $500,000 will remain the same under each situation.

(CPA adapted)

LO1

Transcribed Image Text:

TOTAL ARKANSAS LOUISIANA MISSISSIPPI Sales $8,800,000 $4,400,000 $2,800,000 $1,600,000 Fixed costs: Factory $2,200,000 $1,120,000 $ 560,000 $ 520,000 Administration 700,000 Variable costs 2,900,000 420,000 1,330,000 Allocated home office costs 1,000,000 Total $6,800,000 450,000 $3,320,000 220,000 850,000 350,000 $1,980,000 60,000 720,000 200,000 $1,500,000 Pretax profit from operations $2,000,000 $1,080,000 $ 820,000 $ 100,000