Fern Corporation makes a product called the ALPHA. Fern sells 22,000 units each month for $100 each. Monthly manufacturing costs incurred are summarized in Exhibit One. Senior management of Fern is concerned about the increasing number of competitive products that are emerging in the market where the ALPHA competes. The ALPHA had, until recently, been a dominate player in the marketplace. The success had attracted competitors into the marketplace. These competitors are now producing a higher-quality product than the ALPHA and are seiling it for $90.00 per unit. Management is considering its options. It knows it must drop its selling price to $90.00 per unit if it is to maintain its market share. Demand for the product is expected to remain strong for the next few years but competition will be erce. There will be no perceived difference in quality amongst competitors so unit selling price will be the key consideration for a customer. Fern's management is unsure what the effect on profitability would be if the selling price is reduced to $90.00. Management's objective is to maintain the operating income at its current level. It has asked the product manager for the ALPHA to consider all aspects of design and production with a goal to maintaining the current operating income with the anticipated price reduction. The information gathered by the product manager is summarized in Exhibit Two. Exhibit One ALPHA Cost and Product Information Direct materials Direct labour Machine costs Inspection costs Rework costs Purchasing 8!. Materials Handling (variable) Purchasing ii Materials Handling [xed] Fixed manufacturing costs Design 8: engineering costs (fixed) Exhibit Two $26.00 per unit $4.00 per unit $16.00 per unit $29.00 per testing hour $24.00 per unit reworked $0.65 per unit $14,000 per month $160,000 per month $20,000 per month Information on the ALPHA and the lie-Designed ALPHA Current Situation Considered a variable cost Considered a variable cost Considered a variable cost Direct material Direct labour Machine costs Inspection costs All units are inspected Inspection takes 0.10 hours per unit 6% of all units sold are re- worked Re-work costs Purchasing 81 Materials Handling Considered a variable cost (variable) Purchasing 8: Materials Handling (fixed) Fixed manufacturing costs Design costs Considered a fixed cost Considered a fixed cost Considered a fixed cost Redesigned ALPHA Costs are expected to be 5% lower Labour rates will be 4% higher Design change wlil reduce machine time bv 25% Inspection tlme wlil be reduced by 5%. All units will continue to be inspected. lfa second inspection point is added, it Is possible to reduce the number of units re- worked bv 85%. The cost per unit of the second inspection point Is 4096 of the cost of the first Inspection. Efficiencies in materials handling will reduce the unit cost bv 20% No change is anticipated No change is anticipated Cost increase of $5,000 per month to implement the changes suggested