WCB Co. Part #5

Creating a Flexible Budget

Goal: To create a flexible budget for a new product line. Information: WCBs experiment with power systems harmonics analyses was a great success. Not only were the engineers able to provide an excellent final report to the client, but the staff found the new project to be a welcome change from their normal projects. Based on this success, the management team has decided to make these analyses part of WCBs business model. The sales staff estimates that in the first year they will be able to sell 500 power systems harmonics analysis projects for $15,000 each. In addition, they estimate that each new job will require approximately $900 worth of sales expenses and a 3% sales commission. The accounting department estimates that 35% of the costs from Administrative Support and Marketing are variable and should be included with variable S&A on the new line. The new line will also be assigned $400,000 in fixed administrative support costs, $200,000 in fixed costs from the marketing department, $150,000 in direct supervisor salaries, and $65,000 in direct advertising. Finally, the new supervisor estimates that the new line will require $2,000,000 worth of specialized equipment (computers, sensors, etc.). The new equipment will have an estimated salvage value of $150,000 and an estimated useful life of 5 years.

Assignment: 1. Create a flexible budget for the new power systems harmonics analysis line. 2. What will be the variable NI on the new line? 3. How would the variable NI on the new line change if WCB completed 650 power systems harmonics analysis projects instead of 500? 4. WCBs other option is to price the new line at $16,000 per analysis. At that price, the sales staff estimates that they will only be able to sell 400 projects. What would be the variable NI if this alternative sales price were used? 5. Identify implications and consequences: List and explain two positive and two negative consequences of starting the new line. A good answer will address more than just the net income and cash flow effects of the decision. 6. Based on your answers to the previous questions, do you think WCBs decision to offer this new type of service was a good one? Explain.

Hint: You calculated a total S&A assigned to each power systems harmonics analysis in the previous WCB problem. If you multiply that number by the percentage given in this problem, you will have an administrative variable cost rate.

WCB uses straight-line depreciation.

HINT: You will be using your budget in future problems, so make sure that it is a functioning, Excel-based flexible budget. In other words, you should be able to type in a new level of sales and have it automatically update the rest of your numbers.