Your first stop at the Patterson complex is a meeting with the controller. He provides some additional background: "Jessica, like her predecessors, spent most of her time with customers developing new products to meet customer needs. She didn't concern herself with costs. Customers were willing to pay for products that solved problems. Upon Jessica's retirement, Columbia appointed Paul, our former production manager, to CEO. Paul has done wonders in rationalizing and standardizing our product lines. He substantially reduced manufacturing costs, which led to record profits in the two years following the sale of the company. Those early results have apparently set high expectations for our continuing performance. Our proposal will help move us toward meeting those expectations," he said. "Our proposal is to stop manufacturing our largest-selling product, the Gudgeon EH40, and instead acquire it from an

overseas supplier," continued the controller. "This product currently represents 30% of our total sales revenue and production volume. But sales have been declining because competitors are offering a similar product at lower prices. We think that by reducing our price by 5% we can increase our unit sales volume by 15%. The increased volume coupled with a lower product cost from the offshore supplier should nearly double our firm-wide profit. "The controller also provided some supporting documents. Exhibit 1 summarizes operations for the five years since Patterson Manufacturing was sold to Columbia Holdings. Year 1 represents the first full year after Jessica retired, and Year 5 is the year that just past. Exhibits 2, 3, and 4 provide an income statement for Year 5, the current employee staffing levels by job title, and a detailed price

proposal from the overseas supplier. The controller continued: "The analysis is straightforward. Sales of the Gudgeon EH40 were $27 million last year. The direct material costs came to $14.3 million, while overhead costs of $4.2 million were allocated to the product. But only $2.9 million of the overhead will be avoided if we stop manufacturing the Gudgeon EH40. The remaining overhead costs are nearly all fixed and not subject to reduction soon. Our direct selling costs consist mostly of an 8% commission paid to sales representatives. In addition, there's a $2 million advertising allowance devoted to promoting the Gudgeon EH40 in trade magazines." He also said, "By outsourcing the Gudgeon EH40, we can release three administrative managers, eight administrative support staff, 128 general production personnel, and 10 supervisors. The firm will incur a one-time charge of $1 million for severance pay and pension contributions for dismissed employees. We'll also need to spend $200,000 for the construction of receiving facilities for the outsourced product. "The controller continued: "The supplier's cost quotation (Exhibit 4) needs to be adjusted for the expected 15%

increase in volume. The cost for materials and labor will increase proportionately, but the overhead and 'other' costs are unlikely to be affected. The supplier's mark-up will be 10% of the new total cost. In addition to the product cost, Patterson will incur transportation costs to get the product from the manufacturer to our warehouse. The transportation costs are variable and would have been $0.6 million for the

volume of product in Year 5."

Exhibit 1: Patterson Manufacturing Five-Year Summary of Operations Year 5 Year 4 Year 3 Year 2 Year Total Revenues $90 2 $94.9 $106 2 $171.4 Net Income $31 $3.8 $4.4 $7.3 $7.5 Domestic Sales $747 $76.9 $793 $85.0 $68. International Sales $15 5 19 8 $212 23.3 Sales of Established Products" $739 $75.1 $74.4 $76.3 $76.6 Sales of New Products' $163 $19.8 $24.7 $29.9 $34.8 Research and Development $1.1 $1.5 $1.2 $1.3 Return on Assets 2.0%% 239 2.7% 4.1% 4.2% Number of Employees 185 510 Beer Dollar figures are in milliera. "Euablished products are those that have been ma ream or more. New products have been marketed for less than five pear. Exhibit 2: Exhibit 3: Summary Income Statement for Patterson Manufacturing Distribution of Current Patterson Employees by Job Title Year 5 Number of Average Salary Sales Job Title Employees Per Employee Cost of Goods Sold |COGS) Administrative Manager 10 $45.000 743 Administrative Staff 24 Gross Margin 32 000 159 Production Supervisor Administrative Costs 16 General Production Personnel 417 37 000 Selling Costs 112 Operating Income Never Dollar figures are in miller. Iness superuz and incase tases as only where an Columbia's carsalidated financial statements. Exhibit 4: Off-Shore Supplier's Price Proposal for the Volume of Product in Year 5 ABOUT IMA* Material Costs $127 With a worldwide network of more than 65,000 professionals, Labor Costs 1.8 IMA (Institute of Management Accountants) is the world's Overhead Costs 27 leading organization dedicated to empowering accounting Onthe 15 and finance professionals to drive business performance. Total 187 IMA provides a dynamic forum for professionals to advance their careers through CMA" (Certified Management Profit Mark-Up [10%%) Accountant) certification, research, professional education, Total Price $20.6 networking, and advocacy of the highest ethical and Note: Dollar figures are in millicra. The seal price is queed for supplying the quandry of professional standards. For more information about IMA, product l'anenon sold in Year . "The quand price in FLIB the suppliers manufacturing plant please visit www.imanet.org