Cost Information and Decision Making

Peter Boking has worked as a muffler mechanic for several years and believes that he could make more money by starting his own muffler shop. He has the commitment from his father to finance the business. Peter must decide whether to sell high-quality mufflers intended for the automobile enthusiast or target the regular automobile owner. He has done quite a bit of investigation and believes that he could sell 900 high-quality mufflers a year at $2,000 each. On the other hand, he believes that he could sell 1,200 mufflers if he concentrated on standard mufflers at $1,000 each. The high-end mufflers would cost him $1,050 each while the standard ones would be $400 each. He would spend half his time installing mufflers and would need to hire six mechanics at $20 per hour. The mechanics would work an average of 2,000 hours per year. He has located a place that would be a suitable location, no matter which alternative he chose, at a rent of $120,000 per year. Utilities would be $18,000 per year.

He would need to acquire equipment such as hoists, tools, and storage racks. The nature of the equipment would differ depending on the choice he made with respect to the quality of mufflers being sold. The depreciation would be $105,000 per year for the high-end mufflers and $65,000 per year for the standard mufflers. He has found a person to handle all of the administration of the business at a cost of $50,000 per year, including all administration expenses. Advertising, which would be his only additional selling cost, would be either $15,000 per month for the high-end mufflers or $10,000 per month for the standard mufflers.

He hopes to be able to pay himself a salary of $100,000 for his own efforts in the business, half installation and half selling.

Required:

1. Prepare income statements for each alternative, separating costs into direct and indirect costs.

Income Statement For One Year of Operation High End Standard Direct costs: Total direct Indirect costs: Total indirect 2. Is the business profitable enough for Peter to justify quitting his job and starting his own business? 3. Which alternative should Peter choose? The input in the box below will not be graded, but may be reviewed and considered by your instructor