Chris Collins's Use of Costs in Decision Making: Chris Collins supervised an assembly department in Dexter Electronics Company. Recently, Collins became convinced that a certain component, number S-36. could be produced more efficiently by changing assembly methods. Collins described this proposal to Dexter's industrial engineer, who quickly dismissed Collins's idea- mainly, Collins thought, because the engineer had not thought of the idea first.

Collins felt that producing the S-36 component at a lower cost might provide Collins the opportunity to start a new business. Dexter's purchasing agent assured Collins that Dexter would buy S-36s from Collins if the price were 10 to 15 percent below Dexter's current cost of $1.65 per unit. Working at home. Collins experi- mented with the new assembly method. This experimentation seemed successful, so Collins prepared estimates for large scale S-36 production. Collins determined the following:

1. A local toolmaker would make the required assembly workstations for $800 each. One workstation would be needed for each assembly worker.

2. Assembly workers were readily available, on either a full-time or part-time basis, at a wage of $3.75 per hour. Another 20 percent of wages would be necessary for fringe benefits. Collins estimated that on average (including rest breaks), a worker could assemble. test, and pack 15 S-36s per hour.

3. Purchased components for the S-36 would cost $.85 per unit. Shipping materials and delivery costs would cost $.05 per unit.

4. Suitable space was available for assembly operations at a rental of $600 per month.

5. Collins would receive a salary of $2.000 per month.

6. An office manager was required and would cost $900 per month in salary.

7. Miscellaneous costs, including maintenance, supplies, and utilities, will average about $325 per month (all fixed costs).

8. Dexter Electronics would purchase between 400.000 and 525.000 units of S-36 a year, with 450.000 being Dexter's purchasing agent's "best guess." Collins would have to commit to a price of $1.40 per unit for the next 12 months even though the exact volume would not be known.

Collins showed these estimates to a cost analyst in another electronics firm. This analyst said that the estimates appeared reasonable, but the analyst advised buying enough workstations to enable producing the maximum estimated volume (525.000 units per year) on a one-shift basis (assuming 2,000 labor-hours per assembler per year). Collins thought this was good advice.

Required:

a. What are Collins's expected variable costs per unit? Fixed costs per month? What would be the total costs per year of Collins's business if volume was 400,000 units? 450,000 units? (Limit yourself to cash costs; ignore depreciation of workstation equipment. Also, disregard any interest costs Collins might incur on borrowed funds.)

b. What is the average cost per unit of S-36 at each of these three volumes (400,000, 450,000, and 525,000 units)?

c. Re-answer requirements

(a) and

(b) assuming that (1) Collins wanted to guaran- tee each assembly worker 2,000 hours of pay per year: (2) enough workers would be hired to assemble 450,000 units a year: (3) these workers could work overtime at a cost (including fringes) of $6.75 per hour; and (4) no additional fixed costs would be incurred if overtime were needed. (Do not use these assumptions for requirement [d].)

d. Re-answer requirements

(a) and (b). now including depreciation as a cost. Assume the workstation equipment has a useful life of six years and no salvage value. Straight-line depreciation will be used.

e. Would you encourage Chris Collins to resign from Dexter Electronics and form the proposed enterprise? Assume Chris would need to invest $70,000 for working capital plus whatever is needed for the assembly workstations. Support your answer.