Exercise 1: Relax Company produces three models of digital watches: Sport, City and Elegant. Sales and costing information for the three models are as follows: Data Selling price per unit Units produced and sold Direct materials cost Direct labor cost Sport City Elegant 200 300 400 5,000 3,000 2,000 400,000 300,000 250,000 250,000 150,000 100,000 Traditionally, manufacturing overhead is allocated based on number of direct labor hours. Manufacturing overhead for the period is 1,000,000. Based on this information, management has determined that the Sport model is not breaking even. Because the market for digital watches is competitive, the price for each model is set by the market. Thus, increasing the price charged for products is not an option. As a result, management is considering discontinuing the Sport model. Before making a final decision, management has come to you for advice. You collect the following information regarding manufacturing overhead: Manufacturing Overhead Manufacturing Overhead Allocation basis Costs Engineering 200,000 Quality Control 450,000 Engineering changes Number of setups Manufacturing support 350,000 Number of direct labor hours Total overhead 1,000,000 Allocation Bases Sport City Elegant Engineering changes 7 8 Number of setups 6 11 13 Number of direct labor hours 4,000 3,500 2,500 structions: pala osi 1- Determine the Gross Margin for each model using the ABC allocated manufacturing overhead. 2- What recommendation would you make to management regarding its decision to discontinue the Sport model? 3- Based on cost drivers (engineering changes, number of setups and number of direct labor hours) what recommendation(s) would you make to management to reduce the costs of production?