Assignment Question

Palentir Ltd is an Australian company which produces household consumer durables. The Company prides itself on its efficiency, and rightly so, as it is probably one of the lowest cost producers of household consumer products in Oceania. It has a reputation for high quality, long lived products, and has built up a sound business relationship with most department stores, the main outlet for such goods, in Australia. So good are their products that Orchrist Ltd, the leading department store in Australia refuse to stock any other brand, preferring to associate their good name purely with Palentir products.

Their success has encouraged Palentir Ltd to expand their production capacity recently. Their very success would appear to have caused the downfall of this venture however. Because of the high standing of their products the company has already captured most of the domestic (Australian) market, and owing to the durable nature of their products the replacement demand for goods is low.

At a recent board meeting it was decided that the Company should explore the opportunity of expanding into the export market. Accordingly, enquiries were made to see if there were any opportunities to sell their products in the South Pacific region. The result of these enquiries was disappointing. The only positive response come from a group of businessmen in Tuvalu who were prepared to purchase 2,000 brush cutters but were not prepared to pay more than $880,000 for the entire order. This does not appear to be a lucrative proposition to Palentir Ltd as the statement of unit standard costs and revenues for brush cutters shown below indicates.

Costs	$
Material A (2 kilos)	46
Material B (4 kilos)	60
Material C (2 kilos)	72
Labour grade I (3 hours)	84
Labour grade II (6 hours)	96
Variable overheads	40
Fixed overheads	80
Total unit cost	478
10% mark up on cost for profit	48
	520
10% mark up on selling price for goods and services tax	52
Invoice price customer	572

While no sales tax would be charged on goods sold to the potential buyers in Tuvalu, they insist that the $880,000 should include the $40,000 customs duties which would be charged on the goods. Furthermore, owing to the difference in the type of spirit oil available to power brush cutters in Tuvalu compared to that in Australia certain specifications changes in the design of the brush cutters would have to be made if the order was accepted. These would cost $24 per unit.

The following additional information is available which may or may not be relevant:

• Material A is in common use, its current replacement cost is $28 per kilo, its net realisable value is $26 per kilo.
• Material B is being phased out of use to be replaced with a readily available plastic product. 12,000 kilos of material B are currently in inventory. It can be sold on the open market at $8 per kilo but it will cost $12,000 in advertising to inform the market of its availability. The plastic substitute required to produce one brush cutter will cost $32.
• Material C is obtained as a by-product of another product line. The standard cost of $36 per kilo was designated as appropriate after consultation with a reputable firm of accountants who charged the Company $20,000 for their advice. The material can be neither bought nor sold on the open market. If not used the Company would have to dispose of the material at a cost of $0.40 per kilo. There are at present 5,000 kilos of material C in stock.
• Labour grade I are due to submit a wage claim. It is expected that they will demand 15% but will probably settle for 10%. There is a slight chance that an offer of this sum will precipitate a strike.
• Labour grade II has recently accepted a 10% pay rise, but only after a two week strike. The new pay rise has not been incorporated into the Company's system of standards as yet.
• Standard variable overheads of $40 per unit of production can reasonably be expected and fixed overheads of $80 per unit can be considered an equitable allocation of the fixed overhead burden.
• It will cost $120,000 to transport the brush cutters if the order is accepted.

The following letter has recently been received from Mr. Sartist, managing director of Orchrist Ltd.

Dear Sir,

I understand that you are considering accepting an order from a group of businessmen in Tuvalu for 2,000 brush cutters at an invoice price of $880,000. This sum compares very favourably with your current invoice price of $572 per unit in Australia. If you are able to accommodate the Tuvaluan businessmen I trust that you will be able to offer us, as valued customers, similar terms in the future. If you cannot see your way clear to offering us such terms I shall feel obligated to advise my board to change its policy as to the restocking of Palentir products to the exclusion of other brands of household consumer durables.

I look forward to your early reply.

Yours faithfully,

Mr. Sartist

Managing Director - Orchrist Ltd.

REQUIRED

1. As a member of the board of Palentir Ltd present a report to the board members advising them whether or not the special order from Tuvalu ought to be accepted. Your report should highlight any relevant calculations you feel are appropriate to support your arguments. (15 marks)

1. Before drafting a letter to the managing director of Orchrist Ltd, analyze whether accepting the order in Tuvalu under special terms compromises the market in Australia. Although it is impossible to ship back the grass cutters from Tuvalu to Australia, in your analysis, calculate the relevant cost of the grass cutters if it were to be shipped back to Australia. (10 marks)

1. Draft an appropriate letter to the managing director of Orchrist Ltd explaining why you will be, or not intend, offering them revised terms for purchasing Palentir's brush cutters. (Note: The length of the letter should be like the letter that Mr. Sartist wrote). (5 marks)