Question 2 (20 marks)

Assume that in 2016, Dubbledore Industries changed its processes and trained workers to recognize quality problems and fix them before products are finished and shipped to customers. Quality is now at an acceptable level. The selling price for its key product, RBK10, was increased in 2016 to reflect an increased price for direct materials and additional conversion costs needed to deliver a higher quality product. Sales have increased, even with the increase in price, and returns have decreased. Dubbledores' managers attribute this to higher quality and a price that is still less than their main competitor, Ginko Corporation.Information related to the RBK10 product for the current period and prior period follows:

2015

2016

Units of RBK10 produced and sold

19,000 for 2015

21,500 for 2016

Units returned

1,150 for 2015

550 for 2016

Net sales in units

17,850 For 2015

20,950 For 2016

Selling price

$23 For 2015

$26 For 2016

Direct materials (kilograms) used

47,500 For 2015

51,600 For 2016

Direct material cost per kilogram

$1.25 For 2015

$1.35 For 2016

Manufacturing capacity in units

23,000 For 2015

23,000 For 2016

Total conversion costs

$115,000 For 2015

$149,500 For 2016

Conversion cost per unit of capacity

$5 For 2015

$6.5 For 2016

Selling and customer-service capacity

100 customers for 2015

120 customers For 2016

Total selling and customer-service costs

$11,000 for 2015

$12,600 for 2016

Total selling and customer-service capacity cost per customer

$110 for 2015

$105 for 2016

Advertising staff

4 for 2015

4 for 2016

Total advertising costs

$24,000 for 2015

$28,000 for 2016

Advertising cost per employee

$6,000 for 2015

$7,000 for 2016

Conversion costs in each year depend on production capacity defined in terms of RBK10 units that can be produced, not the actual units produced. Selling and customer-service costs depend on the number of customers that Dubbledore can support, not the actual number of customers it serves. Dubbledore has 95 customers in 2015 and 115 customers in 2016. At the start of each year, management uses its discretion to determine the number of advertising staff for the year. Advertising staff and its costs have no direct relationship with the quantity of RBK10 units produced and sold or the number of customers who buy RBK10.

Required:

a)Calculate the operating income of Dubbledore for 2015 and 2016. (4 marks)

b)Calculate the growth (both revenue and cost effect), price-recovery (both revenue and cost effect), and productivity components that explain the change in operating income from 2015 to 2016. (10 marks)

c)What type of strategy is Dubbledore pursuing: cost leadership or value leadership? Support your answer using the variances calculated in question 2 (i.e., explain how the variances may demonstrate the company is pursuing a particular strategy). (6 marks)