A company manufactures a single product in its factory utilizing 60% of its capacity. The price and
Question:
A company manufactures a single product in its factory utilizing 60% of its capacity. The price and cost details are given as follows:
An analysis of the fi xed overhead reveals that 12.5% of factory overheads and 20% of selling and distribution overheads are variable with production and sales. But administration overheads are wholly fi xed. Since the existing product could not achieve the budgeted level for two consecutive years, the company decides to introduce a new product with marginal investment but largely using present plant and machinery.
The cost estimates of the new product are as follows:
It is expected that 2,000 units of the new product can be sold at a price of Rs. 30 per unit. The fi xed factory overheads are expected to increase by 10% while fi xed selling and distribution expenses will go up by Rs. 6,250 annually. Administration overheads remain unchanged. However, there will be an increase of working capital to the extent of Rs. 37,500 which would take the total project cost to Rs. 4,37,500.
The company considers that 20% pre-tax and interest return on investment are the minimum acceptable things to justify any new instrument.
Required: 1. Should the new product be introduced? 2. Given the data above and making any assumptions that you would consider appropriate, are there any further observations or recommendations you wish to make?
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