Sharpto Fabricators Corporation manufactures a variety of parts for the automotive industry. The company uses a job-order costing system with a plantwide predetermined overhead rate based on direct labor-hours. On December 10, 2015, the companys controller mad a preliminary estimate of the predetermined overhead rate for 2016. The new rate was based on the estimated total manufacturing overhead cost of $2,475,000 and the estimated 52,000 total direct labor-hours for 2016:

Predetermined overhead rate = $2,475,000

52,000 hours

=$47.60 per direct labor-hour

This new predetermined overhead rate was communicated to top managers in a meeting on December 11. The rate did not cause any comment because it was within a few pennies of the overhead rate that had been used during 2015. One of the subjects discussed at the meeting was a proposal by the production manager to purchase an automated milling machine built by Central Robotics. The president of Sharpton Fabricators, Kevin Reynolds, agreed to meet with the regional sales representative from Central Robotics to discuss the proposal.

Shortly after this meeting, Mr. Reynolds informed the companys controller of the decision to lease the new equipment, which would be installed over the Christmas vacation period. The controller realized that this decision would require a re-computation of the predetermined overhead rate for the year 2016 since the decision would affect both the manufacturing overhead and the direct labor-hours for the year. After talking with both the production manager and the sales representative from Central Robotics, the controller discovered that in addition to the annual lease cost of $300,000, the new machine would also require a skilled technician/programmer who would have to be hired at a cost of $45,000 per year to maintain and program the equipment. Both of these costs would be included in factory overhead. There would be no other changes in total manufacturing overhead cost, which is almost entirely fixed. The controller assumed that the new machine would result in a reduction of 6,000 direct labor-hours for the year from the levels that had initially been planned. When the revised predetermined overhead rate for the year 2016 was circulated among the companys top manager, there was considerable dismay.

Re-compute the predetermined overhead rate assuming that the new machine will be installed. Explain why the new predetermined overhead rate is higher (or lower) than the rate that was originally estimated for the year 2016.

What effect (if any) would this new rate have on the cost of jobs that do not use the new automated milling machine?

Why would managers be concerned about the new overhead rate?

After seeing the new predetermined overhead rate, the production manager admitted that he probably wouldnt be able to eliminate all of the 6,000 direct labor-hours. He had been hoping to accomplish the reduction by not replacing workers who retire or quit, but that would not be possible. As a result, the real labor savings would be only about 2,000 hours one worker. Given this additional information, evaluate the original decision to acquire the automated mailing machine from Central Robotics.