Question

To facilitate a move toward JIT production, AB Company is considering a change in its play layout. The plant controller, Anita Bentley, has been asked to evaluate the costs and benefits of the change in plant layout. After meeting with production and marketing managers, Anita has compiled the following estimates:

- Machine moving and reinstallation will cost $100,000

- Total sales will increase by 20% to $1,200,000 because of a decrease in production cycle time required under the new plant layout.  Average contribution margin is 31% of sales.

- Inventory held will decrease by 25%.  Currently, the annual average carrying value of inventory is $200,000.  The annual inventory financing cost is 15%.

Calculate the net benefit/loss from this proposed change for year one.

Machine moving and reinstallation
Increase in contribution margin
Savings in inventory carrying costs
Net benefit/loss of change

Answer 1

Answer:- Increase in Sales Revenue = ($1200000 *20 / 120)= $200000

Increase in Contribution Margin = Increase in Sales Revenue * Average Contribution Margin

= $200000 *31%

= $62000

Savings in Inventory Related Costs = Annual Average Carrying Value of Inventory * Decrease in Inventory Related Costs * Annual Inventory Financing Cost

= $200000 *25% *15%

= $7500

Increase in Benefits = Increase in Contribution Margin + Savings in Inventory Related Costs= $62000 + $7500 = $69500

Net Benefit or Loss = Increase in Benefits – Increase in Costs= $69500 - $100000

= -$30500

Decision:-AB Company should not implement the proposed change in plant layout because the increase in benefits is less than the increase in costs, resulting in a net loss of $30500.