case study discussion
Sofak Company is a manufacturer of precision sensing equipment. Jerry Adams, one of Sofak's project engineers, has developed a prototype of an automatic testing kit that could continually evaluate water quality and chemical content in hot tubs. Adams believes that this kit will permit domestic tub owners to control water quality better at substantially reduced costs and with less time invested. The management of Sofak is convinced that the kit will have strong market acceptance. Furthermore, this new equipment uses the same technology that Sofak employs in the manufacturing of some of its other equipment. Therefore Sofak can use existing facilities to produce the product. Adams is ready to proceed with developing cost and profit plans for the testing kit. He asked the marketing department to develop a suggested selling price and estimate the sales volume. The marketing department contracted with Statico, a marketing research company, to develop price and volume estimates. Based on an analysis of the market, Statico considered unit prices between $80 and $120. Within this price range, it recommended a price of $100 per kit. The frequency distribution of the unit sales volume that Sofak could expect at this selling price is presented below. Estimated Unit Sales Volume at $100 Annual Unit Sales Volume Probability 50,000 .25 60,000 .45 70,000 .20 80,000 .10 1.00 Sofak's profit planning department accumulated cost data that Adams had requested. The new product will require direct materials costing $25.00 per unit and will require two hours of direct-labor time to manufacture. Sofak is currently in contract negotiations with its union, making any projections of labor costs difficult. The current direct-labor cost is $8.00 per direct-labor hour (DLH). Representatives of management who are negotiating with the union have estimated the possible settlements and related probabilities that are shown below. PROBABILITY OF SETTLEMENT AMOUNTS Direct-Labor Cost Per Hour Probability $8.50 .30 $8.80 .50 $9.00 .20 1.00 Sofak applies manufacturing overhead to its products using a plantwide rate of $15.00 per DLH. This rate was based on a planned activity level of 900,000 DLH, which represents 75% of practical capacity. The budgeted manufacturing overhead costs for the current fiscal year are presented below. Sofak Company Schedule of Budgeted Manufacturing Overhead Costs For the Fiscal Year Ending November 30, 19_6 Budgeted Annual Cost Cost per DLH Variable manufacturing overhead costs: Supplies $ 360,000 $ 0.40 Material handling 315,000 0.35 Heat, light, power 1,125,000 1.25 Fixed manufacturing overhead costs: Supervisory salaries 1,440,000 60 Depreciation--building 4,410,000 4.90 Depreciation--equipment 3,420,000 3.80 Property taxes on factory 1,620,000 1.80 Insurance 810,000 0.90 Total budgeted manufacturing overhead costs $13,500,000 $15.00 The introduction of the new product will require some changes in the manufacturing plant. While the plant is below capacity and current facilities can be used, a new production line requiring a supervisor would be opened. The annual cost of the supervisor would be $28,000. In addition, one piece of equipment that Sofak does not own would have to be obtained under an operating lease at an annual cost of $150,000. Sofak has already paid Statico $132,000 for the marketing study that was mentioned previously. Statico has agreed to conduct the promotion and distribution of the new product for a fee of $6.00 per unit once Sofak introduces it. Required Determine the annual pre-tax advantage (disadvantage) that Sofak Company could expect from the introduction of the new product
