COSTING ISSUES FOR MOBILE PHONE MANUFACTURER

AirVoice manufactures mobile phones for the Asia market. It has been in business for
the past ten years, producing the mobile phones from a factory based in Singapore. It
has been profitable for the past few years but the intensifying competition has the
owner of AirVoice, concerned about the competitiveness of their products.
They have asked their Finance Department to pull up some data on the costs of the
AirVoice’s operations for the past year. Other than a factory building, AirVoice’s
headquarters, housing its senior management staff and marketing department, is
located in the financial district, close to where the headquarters of its clients.

Exhibit I shows the data of the fixed cost of AirVoice for last year.
Exhibit I: Cost Data of AirVoice (Last Year)
Cost Category Cost
General Administration (GA) $10m
Marketing Department Salaries and Expenses (Mktg) $2m
HQ Office Space Rental (HQ) $1m
Other Expenses and Fees (Legal, Audit, Consulting) (OE) $2m
Rental of Factory $1m
Factory Equipment Depreciation $2m
Maintenance of Equipment $1m
Quality Control Department $500,000
Utilities for Factory $8m

AirVoice manufactures three product lines in the factory, each targeted at a specific
market segment. The product lines are Kid Phone (KP), Office Phone (OP) and
Luxury Phone (LP). The volume produced and relevant direct costs for these three
product lines are given in Exhibit II.
Exhibit II: Production Volume, Material and Labour Costs for KP, OP and LP
(Last Year)

Product Line Volume Material Cost Operator Cost

Kid Phone KP 1m $10m $1m

Office Phone OP 3m $90m $6m
Luxury Phone LP 0.5m $25m $2m

With the dropping prices brought on by the competition, the company wishes to
establish the minimum price that they can sell the mobile phones and still make a
profit. To determine this, they need to find out:

(i) What is the unit cost for each of the models assuming the total
production volume of 4.5m units as shown in Exhibit II? (Unit costs)

The average prices and volumes of the three models sold by AirVoice last year are
shown in Exhibit III.
Exhibit III: Average Prices and Volume Sold (Last Year)
Models
KP OP LP
Market Price $30 $70 $120
Last Year’s Sales Volume 700,000 2.6m 450,000

Using the data form Exhibits I, II and III, determine

(ii) The profit that AirVoice made last year? (Total Cost Concept)
Assume that AirVoice borrows money to fund its operations and this debt incurs an
interest of $10m last year. Also assume that the tax rate is 20%.AirVoice think of
stopping production on the least profitable of the three models and shifting all the
production capacity freed to the most profitable model in order to improve the
profitability of AirVoice.
 (ii) What is the implication of the proposed action on the profit margin of
the remaining product models? (Fixed and Variable Costs Behavior)
What is the increase/decrease in the total for the AirVoice?
(Incremental Cost and Opportunity Cost)
Assume that
(a) The total capacity of the plant is as shown in Exhibit III;
(b) AirVoice can sell all that it can produce; and
(c) The time taken to make each unit of each of the three models are in the ration of
KP: OP: LP = 1:2:4
It takes 4 times as long to build 1 LP as it does to build 1 KP.

Implication: Shifting production from one model to another under a full capacity
situation may result in more or less total number of mobile phones made.
Finally, the company is prepared to close the plant if they cannot sell enough of the
mobile phones to cover all the costs.

(iv) What is the minimum dollar value of sales before it becomes unprofitable to
run the plant over the long term, assuming that the product mix does not
change? (Breakeven Analysis)