In February 2019 Joe Strong was appointed as general manager by Paul Hunter, president of Hunter Manufacturing Company. Strong, age 56, had wide executive experience in manufacturing products similar to those of the Hunter Company. The appointment of Strong resulted from management problems arising from the death of Richard Hunter, founder and, until his death in early 2018, president of the company. Paul Hunter had only four years experience with the company, and in early 2019 was 34 years old. His father had hoped to train Paul over a 10-year period, but the fathers untimely death had cut short this seasoning period. The younger Hunter became president after his fathers death and had exercised full control until he hired Mr. Strong. Paul Hunter knew that he had made several poor decisions during 2018 and that the morale of the organization had suffered, apparently through lack of confidence in him. When he received the 2018 income statement (Exhibit 1), the loss of almost $200,000 during a relatively good year for the industry convinced him that he needed help. He attracted Mr. Strong from a competitor by offering a stock option incentive in addition to salary, knowing that Strong wanted to acquire financial security for his retirement. The two men came to a clear understanding that Strong, as general manager, had full authority to execute any changes he desired. In addition, Strong would explain the reasons for his decisions to Mr. Hunter and thereby train him for successful leadership upon Strongs retirement. Hunter Manufacturing Company made only three industrial products, 101, 102, and 103, in its single plant. These were sold by the company sales force for use in the processes of other manufacturers. All the sales force, on a salary basis, sold the three products but in varying proportions. Hunter sold throughout New England, where it was one of eight companies with similar products. Several of its competitors were larger and manufactured a larger variety of products. The dominant company was Stellar Company, which operated a plant in Hunters market area. Customarily, Stellar announced prices, and the other producers followed suit. Price cutting was rare; the only variance from quoted selling prices took the form of cash discounts. In the past, attempts at price cutting had followed a consistent pattern: all competitors met the price reduction, and the industry, as a whole, sold about the same quantity but at the lower prices. This continued until Stellar, with its strong financial position, again stabilized the situation following a general recognition of the failure of price cutting. Furthermore, because sales were to industrial buyers and the products of different manufacturers were similar, Hunter was convinced it could not unilaterally raise prices without suffering volume declines. During 2018, Hunters share of industry sales was 12 percent for type 101, 8 percent for 102, and 10 percent for 103. The industrywide quoted selling prices were $9.41, $9.91, and $10.56, respectively. Strong, upon taking office in February 2019, decided against immediate major changes. Rather, he chose to analyze 2018 operations and to wait for results of the first half of 2019. He instructed the accounting department to provide detailed expenses and earnings statements by products for 2018 (see Exhibit 2). In addition, he requested an explanation of the nature of the costs including their expected future behavior (see Exhibit 3). To familiarize Paul Hunter with his methods, Strong sent copies of these exhibits to Hunter, and they discussed them. Hunter stated that he thought product 103 should be dropped immediately as it would be impossible to lower expenses on product 103 as much as 76 cents per hundredweight (cwt.). In addition, he stressed the need for economies on product 102. Strong relied on the authority arrangement Mr. Hunter had agreed to earlier and continued production of the three products. For control purposes, he had the accounting department prepare monthly statements using as standard costs the actual costs per cwt. from the 2018 profit and loss statement (Exhibit 2). These monthly statements were his basis for making minor marketing and production changes during the spring of 2019. Late in July 2019, Strong received from the accounting department the six months statement of cumulative standard costs including variances of actual costs from standard (see Exhibit 4). They showed that the first half of 2019 was a profitable period. During the latter half of 2019, the sales of the entire industry weakened. Even though Hunter retained its share of the market, its profit for the last six months was small. In January 2020, Stellar announced a price reduction on product 101 from $9.41 to $8.47 per cwt. This created an immediate pricing problem for its competitors. Strong forecast that if Hunter Company held to the $9.41 price during the first six months of 2020, their unit sales would be 750,000 cwt. He felt that if they dropped their price to $8.47 per cwt., the six months volume would be 1,000,000 cwt. Strong knew that competing managements anticipated a further decline in activity. He thought a general decline in prices was quite probable. 4 The accounting department reported that the standard costs in use would probably apply during the first half of 2020, with two exceptions: materials and supplies would be about 5 percent above standard, and light and heat would decrease about 3 percent. Strong and Hunter discussed the product 101 pricing problem. Hunter observed that especially with the anticipated increase in materials and supplies costs, a sales price of $8.47 would be below cost. He therefore wanted the $9-41 to be continued since he felt the company could not be profitable while selling a key product below cost.

Required 1. If the company had dropped product 103 as of January l, 2019, what effect would that action have had on the $151,000 profit for the first six months of 2019? 2. What is Hunters most profitable product for the first six months of 2019? 3. In January 2020, should the company reduce the price of product 101 from $9.41 to $8.47? 4. An external supplier can produce product 103 for 9 per unit. If Hunter assigns the production of the product to the external supplier, its fixed costs will be reduced by 10%. Should Hunter outsource the product? EXHIBIT 1 HUNTER MANUFACTURING COMPANY Income Statement For Year Ending December 31, 2018 Gross sales................................................................................................................ 40,690,234 Cash Discounts ......................................................................................................... 622,482 Net Sales .................................................................................................................. 40,067,752 Cost of Sales............................................................................................................. 25,002,386 Gross Margin............................................................................................................ 15,065,366 Less: Selling Expense ............................................................................................ 7,058,834 General Administration ................................................................................ 2,504,597 Depreciation ................................................................................................. 5,216,410 14,779,841 Operating Income ..................................................................................................... 285,525 Other Income ............................................................................................................ 78,113 Income before interest ............................................................................................. 363,638 Less: Interest expense .............................................................................................. 555,719 Income (loss) ............................................................................................................ (192,081) 5 EXHIBIT 2 Analysis of Profit and Loss by Product Year Ended December 31, 2018 Product 101 Product 102 Product 103 Thousands $ per Cwt. Thousands $ per Cwt. Thousands $ per Cwt. Total Thousands Rent ....................................... 450 0.2111 450 0.437 600 0.6079 1,500 Property taxes........................ 300 0.1407 145 0.1408 139 0.1408 583 Property insurance................. 286 0.1341 138 0.134 132 0.1337 556 Compensation insurance ....... 599 0.2809 284 0.2758 317 0.3212 1,200 Direct labor ........................... 4,964 2.3281 2,341 2.2736 2,640 2.6748 9,945 Indirect labor ......................... 1,693 0.794 814 0.7906 883 0.8947 3,390 Power .................................... 86 0.0403 96 0.0932 116 0.1175 298 Light and heat ....................... 43 0.0202 43 0.0418 58 0.0588 144 Building service .................... 29 0.0136 29 0.0282 39 0.0395 97 Materials ............................... 2,935 1.3765 1,809 1.7569 1,862 1.8866 6,606 Supplies ................................. 201 0.0943 183 0.1777 135 0.1368 519 Repairs .................................. 68 0.0319 57 0.0554 39 0.0395 164 Total production cost ............ 11,654 5.4657 6,388 6.204 6,960 7.0519 25,002 Selling expense ..................... 3,496 1.6396 1,758 1.7074 1,805 1.8288 7,059 General administration .......... 1,241 0.582 624 0.606 640 0.6484 2,505 Depreciation .......................... 2,169 1.0173 1,643 1.5957 1,404 1.4225 5,216 Interest .................................. 201 0.0943 153 0.1486 202 0.2047 556 Total cost............................... 18,761 8.7989 10,566 10.2617 11,011 11.1563 40,338 Less other income ................. 39 0.0183 20 0.0194 19 0.0193 78 18,722 8.7806 10,546 10.2423 10,992 11.1371 40,260 Sales (net) ............................. 19,847 9.3083 9,978 9.6906 10,243 10.3782 40,068 Profit (loss) ........................... 1,125 0.5276 -568 -0.5516 -749 -0.7589 -192 Unit sales (cwt.) .................... 2,132,191 1,029,654 986,974 Quoted selling price .............. 9.41 9.91 10.56 Cash discounts taken, percent of selling price....................... 1.08% 2.21% 1.72% Note: Figures may not add exactly because of rounding 6 EXHIBIT 3 Accounting Departments Commentary on Costs Direct Labor Variable. Compensation insurance Variable, Nine percent of direct and indirect labor is a good estimate. Materials Variable. Exhibit 2 figures are accurate. Includes waste allowances. Power Variable. Rates are fixed. Supplies Variable. Exhibit 2 figures are accurate. Repairs Variable. Varies as volume changes within normal operating range. Lower an PP General administration, selling expense, indirect labor, interest Almost non-variable. Can be changed by management decision. Cash discount Almost non-variable. Average cash discounts taken are consistent from year to year, percentages in Exhibit 2 are accurate. Light and heat Almost non-variable. Heat varies only with fuel cost changes. Light is a fixed item regardless of level of production. Property taxes Almost non-variable. Under the lease terms, Hunter Company pays the taxes, assessed valuation has been constant; the rate has risen slowly. Any change in the near future will be small an independent of production volume. Rent Non-variable. Lease has five years to run. Building service Non-variable. At normal business level, variances are small. Property insurance Non-variable. Three-year policy with fixed premium. Depreciation Non-variable. Fixed-dollar total. 7 EXHIBIT 4 Profit and Loss by Product, at Standard Showing Variances from January 1 to June 30, 2019 Product 101 Product 102 Product 103 Item Standard per Cwt. Total at Standard Standard per Cwt. Total at Standard Standard per Cwt. Total at Standard Total Standard (thousands) Total Actual (thousands) Varian ces Rent ..............................0.2111 210 0.4370 311 0.6079 305 826 750 -76 Property taxes ...............0.1407 140 0.1408 100 0.1408 71 311 303 -8 Property insurance ......................0.1341 134 0.1340 95 0.1337 67 296 278 -18 Compensation insurance ......................0.2809 280 0.2758 196 0.3212 161 637 633 -4 Direct labor...................2.3281 2,321 2.2736 1,619 2.6748 1,341 5,281 5,308 +27 Indirect labor ................0.7940 792 0.7906 563 0.8947 448 1,803 1,721 -82 Power ...........................0.0403 40 0.0932 66 0.1175 59 165 170 +5 Light and heat ...............0.0202 20 0.0418 30 0.0588 29 79 83 +4 Building service ...........0.0136 14 0.0282 20 0.0395 20 54 50 -4 Materials .......................1.3765 1,372 1.7569 1,251 1.8866 946 3,569 3,544 -25 Supplies ........................0.0943 94 0.1777 127 0.1368 69 290 290 Repairs .........................0.0319 32 0.0554 39 0.0395 20 91 88 -3 Total production cost ...............................5.4657 5,449 6.2050 4,417 7.0518 3,536 13,402 13,218 -184 Selling expense .............1.6396 1,634 1.7074 1,216 1.8288 917 3,767 3,706 -61 General administration ...............0.5820 580 0.6060 432 0.6484 325 1,337 1,378 +41 Depreciation .................1.0173 1,014 1.5957 1,136 1.4225 713 2,863 2,681 -182 Interest ..........................0.0943 94 0.1486 106 0.2047 103 303 290 -13 Total cost ......................8.7989 8,771 10.2617 7,307 11.1563 5,592 21,672 21,273 -399 Less other income.........0.0183 18 0.0194 14 0.0193 10 42 42 8.7806 8,753 10.2423 7,294 11.1371 5,583 21,630 21,231 -399 Actual sales (net) ..........9.3083 9,279 9.6906 6,901 10.3782 5,202 21,382 21,382 Profit or loss .................0.5276 526 -0.5516 -393 -0.7589 -380 -248 151 +399 Unit sales (cwt.) ........... 996,859 712,102 501,276 Note: Figures may not add exactly because of rounding