JAMIE KINCADE

Jamie Kincade was supervisor of an assembly department in Chelsea Electronics

Company. In recent weeks, Kincade had become convinced that a certain
component, number J-42 could be produced more efficiently if certain changes were
made in assembly methods. Kincade had described this proposal to the company’s
industrial engineer, but the engineer had quickly dismissed Kincade’s ideas-mainly.
Kincade thought, because the engineer had not thought of them first.

Kincade had frequently thought of starting a business and felt that the ability to
produce the J-42 component at a lower cost might provide this opportunity.
Chelsea’s purchasing agent assured Kincade that Chelsea would be willing to buy J-
42s from KIncade if the price were 10-15% below Chelsea’s current cost of $2.97
per unit. Working at home, Kincade experimented with the new methods, which
were based on the use of a new fixture to aid in assembling each J-42. This
experimentation seemed successful, so Kincade proceeded to prepare some
estimates for large-scale J-42 production. Kincade determined the following :

1. A local toolmaker would make the new fixtures for a price of $900 each. One
fixture would be needed for each assembly worker

2. Assembly workers were readily available, on either a full time or part time
basis, at a wage of $6,75 per hour. Kincade felt that another 20% of wages
would be necessary for fringe benefits. Kincade estimated that on the
average (including rest breaks), a worker could assemble, test, and pack 15
units of the J-42 per hour

3. Purchased components fort the J-42 should cost about $1.53 per nit over the
next year. Shipping supplies and delivery costs would amount to
approximately $0.09 per unit

4. Suitable space was available for assembly operations at a rental of $1,080

per month. A 12-moth lease was required

5. Assembly tables, stools, and other necessary equipment would cost about
$540 per assembly worker

6. Kincade, as a general manager, would receive a salary of $3,600 per month

7. A combination office manager-book keeper was available for a salalry of

$1,260 per month

8. Miscellaneous costs, including maintenance, supplies, and utilities, were

expected to average about $855 per month

9. Chelsea Electronics would purchase between 400,000 and 525,000 units of J-

42 a year, with 450,000 being Chelsea’s purchasing agent’s “best guess”.
 However, Kincade would have to commit to a price of $2.52 per unit for the
next 12 months

Kincade showed these estimates to a friend who was a cost analyst in another
electronics firm. This friend said that all of the estimates appeared reasonable, but
told Kincade that in addition to the required investment in fixtures and equipment,
about $125.000 would be neede to finance accounts receivable and inventories. The
friend also advised buying enough fixtures and other equipment to enable
producing the maximum estimated volume (525.000 units per year) on a one-shift
basis (assuming 2.000 labor-hours per assembler per year). Kincade thought this
was good advice.

Question :

1. What are kincade’s expected variable costs per unit? Fixed costs per month?
What would the total costs per year of Kincade’s business be if volume were
400.000 units? 450.000 units? 525.000 units? (Limit yourself to cash costs;
ignore depreciation of fixtures and equipment. Also, disregard any interest
cost Kincade might incur on borrowed funds)

2. What is the average cost per unit of J-42 at each of these three volumes?

3. Reanswer questions 1 and 2 assuming that

a. Kincade wanted to guarantee assembly workers 2,000 hours of pay per

year

b. Enough workers would be hired to assemble 450.000 units a year

c. These workers could work overtime at a cost (including fringes) of $12.15

per hour

d. No additional fixed costs would be incurred if overtime were needed (do

not use these assumptions for question 4)

4. Reanswer questions 1 and 2, now including depreciation as an expense.

Assume the fixtures and other equipment have a useful life of 6 years, and
that straight-line depreciation will be uased.

5. Do you think Jamie Kincade should resign from Chelsea Electronics and
establish the proposed enterprise?
HOSPITAL SUPPLY, Inc

Hospital Supply, Inc; produced hydraulic hoists that were used by hospitals to
move bedridden patients. The cost of manufacturing and marketing hydraulic
hoists at the company’s normal volume of 3,000 units per month are shown
below :

Unit ManufacturingCosts:
Variable materials 550
Variable labor 825
Variable overhead 420
Fixed overhead 660
Total Unitmanufacturingcosts 2455

Unit MarketingCosts:
Variable 275
Fixed 770
Total unitmarketingcosts 1045
Total UnitCosts 3500

Questions :

The following questions refer only to the data given above. Unless otherwise
stated, assume there is no connection between the situations described in the
questions; treat each independently. Unless otherwise stated, assume a regular
selling price of $4,350 per unit. Ignore income taxes and other costs not
mentioned above or in a question itself
1. What is the break-even volume in units? In sales dollars?

2. Market research estimates that monthly volume could increase to 3,500

units, which is well within hoist production capacity limitations, If the price
were cut from $4,350 to $3,850 per unit. Assuming the cost behavior
patterns implied by the data in the table given are correct, would you
recommend that this action be taken? What would be the impact on monthly
sales, costs, income?

3. On March 1 a contract offer is made to Hospital Supply by the federal

government to supply 500 units to Veterans Administration hospitals for
delivery by March 31. Because of an unusually large number of rush orders
from their regular customers, Hospital Supply plans to produce 4,000 units
during March, which will use all available capacity. If the government order is
accepted, 500 units normally sold to regular customers would be lost to a
competitor. The contract given by the government would reimburse the
government’s share of March production costs, plus pay a fixed fee (profit) of
$275,000 (there would be no variable marketing costs incurred on the
government’s units). What impact would accepting the government contract
have on March income?

4. Hospital supply has an opportunity to enter a foreign market in which price

competition is keen. An attraction of the foreign market is that demand there
is greatest when demand in the domestic market is quite low; thus. Idle
production facilities could be used without affecting domestic business. An
order for 1,000 units is being sought at a below normal price in order to enter
this market. Shipping costs for this order will amount to $410 per unit, while
total costs of obtaining the contract (marketing costs) will be $22,000.
Domestic business would be unaffected by this order. What is the minimum
unit price Hospital Supply should consider for this order of 1,000 units?

5. An inventory of 200 units of an obsolete model of the hoist remains in the

stockroom. There must be sold through regular channels at reduced prices or
the inventory will soon be valueless. What is the minimum price that would
be acceptable in selling these units?

6. A proposal is received from a outsider contractor who will make 1,000

hydraulic hoist units per month and ship them directly to Hospital Supply’s
customers as orders are received from Hospital Supply’s sales force. Hospital
Supply’s foxed marketing costs would be unaffected, but its variable
marketing costs would be cut by 20% (to $220 per unit) for these 1,000 units
produced by the contractor. Hospital Supply’s plant would operate at two-
thirds of its normal level, and total fixed manufacturing costs would be cut by
30% (to $1,386,000). What in house unit cost should be used to compare with
the quotation received (payment to the contractor) of $2,475 per unit
7. Assume the same facts as above in question 6 except that the idle facilities
would be used to produce 800 modified hydraulic hoists per month for use in
hospital operating rooms. These modified hoists could be sold for $4,950
each, while the variable manufacturing costs would be $3,025 per unit.
Variable marketing costs would be $550 per unit. Fixed marketing and
manufacturing costs would be unchanged whether the original 3,000 regular
hoists were manufactured or the mix of 2,000 regular hoists plus 800
modified hoists was produced. What is the maximum purchase price per unit
that Hospital Supply should be willing to pay the outside contractor? Should
the proposal be accepted for a price of $2,475 per unit to the contractor?