Giulia Ferrato, a recent MBA graduate, has developed a high-quality piton, a tool

used in mountain climbing. Owing to the security of a customer's offer to guarantee

a significant level of demand for a two-year period, she agreed to take over the forge

needed for production. She is now trying to decide whether or not to introduce a

new product line, a wall hammer. Some of the current capacity can be used to make

this product, but its manufacture would incur some new costs. A move away from

offering only a single product line also raises the issue of cost allocations.

Keywords: Multiproduct breakeven; Relevant costing; Accounting payback period;

Cost allocation

Learning Objectives

An entrepreneur has recently taken over a forge operation needed to produce the

single product upon which the business was built. She has an idea for a new product

line that can be manufactured using much of the currently available capacity.

However, some new resources will also be needed and the movement toward

becoming a multi-product company means the owner faces the need to allocate

common production costs. The case asks students to analyze the financial effect of

adding the new product line.

Learning Objectives

Introduce the concept of multiproduct product breakeven: Sales mix

Incremental costing on decision to add a product line: Relevant variable

costs, Relevant fixed costs

Accounting payback period

Introduction of the need to allocate costs: Directly traceable, Common costs

Identify options for the resources contained in the business: Limitations and

opportunities related to the cost structure

Assignment Questions

1. TenAlpina is adding a new product line, which will add some new costs as

well. Based on Giulia's estimates, and assuming that the volumes for piton

production and sales do not change, how many wall hammers would

Ten Alpina Tools have to sell in order to have the same annual gross margin

(in dollars) as it would have if only pitons were sold? That is, at what demand

level for hammers would Guilia be indifferent (from a total profitability point

of view) as to whether or not to add the new product line?

2. In question 1 you computed the number of hammers to sell to find a point of

indifference for demand to decide whether or not to add the hammers. Now,

using Giulia's estimates and assumptions for both piton and hammer

production and sales, what would be the total annual aggregate effect on

total gross margin of adding the production and sales of the new wall

hammer product line?

3. Given the uncertainty of demand, Giulia is concerned about the payback

period for the investment in the new moulding machine. Using Giulia's

assumptions about demand, compute the payback period from an income

and from a cash flow point of view. Be prepared to provide quantitative

support for your answer.

4. Giulia wanted to look at financial risk another way, from a breakeven and

margin of safety point of view. What is the breakeven point and margin of

safety for TenAlpina? Assume the mix of 4200 pitons for every 350 hammers

will remain fairly constant.

5. Now assuming the rock hammers have been added, and employing the

estimates and assumptions provided in the case, what will be the unit gross

margins for each of the two product lines?

6. Focusing on the pitons, how can you explain to Giulia the logic behind the

results of your computations? That is explain the results in conceptual terms,

not in terms of the computational mechanics.