Question

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You are an eager and ambitious young graduate of the Reginal F. Lewis College of Business at Virginia State University with a new Accounting degree and a great life ahead of you. One of your closest friends is an inventor and an entrepreneur who wants to start a business selling a break-through new drywall screw that he has invented and that he believes works much better than the drywall screws currently on the market. He wants to start the business by opening a factory to produce the screws which can then be sold to either wholesalers or retailers who will then sell them to the general public. After searching all over creation for the right sized building in the perfect location to properly meet the needs of his target customers, he found that the ideal building in which to put up his factory was right here in Petersburg all along.                              

To begin, he was able to purchase the building he needed outright for $500,000. Useful life of the building is 40 years and it is depreciated on a straight-line basis. Estimated salvage value is $25,000. Property taxes on the building each year are $3,000.                                                                                                                                                   

There is a new machine that another fellow VSU grad has invented that takes the metal for the screws and molds them into their proper size and shape, and takes the plastic for the anchors and molds them into their proper size and shape; an assembly line is attached to the machine where workers put the screws and anchors into boxes. The finished product is a box of 32 drywall screws and their plastic anchors that work unlike any that have come before them. He purchased this machine outright for $150,000. The machine has a useful life of 20 years with no residual value and is depreciated on a straight-line basis. The machine can produce 17,500 boxes of screws and anchors per year. He is sure that he can sell every unit produced.                                                                                                                                                                                

It is determined that to produce the 32 screws in each box will require 128 ounces of metal which is the only material used to make the screws and to produce the 32 anchors in each box will take 32 ounces of plastic which is the only material used to make the anchors. The metal you need is produced by multiple suppliers and you've found one so far that will allow you to buy it at $1.50 per pound. The plastic used is also produced by multiple suppliers and you've found one so far that will allow you to buy it at $.15 per pound. It takes 15 minutes for the workers on the assembly line to box the screws and anchors because they are put in there in a way that prevents them from becoming disorderly. This is part of the quality aspect of the product. Assembly line workers are paid at a rate of $20.00 per hour.                                                                                                    

Your friend hired a Vice President (VP) who has a degree in Marketing from VSU. She did some market research and determined that in order to be competitive with your new product you are going to charge $25.00 per box of screws and anchors. The Vice President is paid $57,500 per year. He also hired a Chief Operating Officer who will be paid $57,500 per year. Your friend has also asked you to serve as a consultant to his company to make sure that the business gets off to a good start. Your fee has not yet been determined and is not part of this problem.   

Required:

Answer the questions above.                                                                                                                 

Prepare a variable costing format income statement assuming that the company makes and sells the maximum possible number of units. If the income is negative, what is the reason?

Your friend asks you for advice on how to increase the company income. Give him at least two possible solutions to the problem.                                                

Which solution did you recommend to your friend? Why did you choose this particular solution?

Prepare a memo addressed to your friend/client explaining your options and your recommendation. This memo should be no more than one page long.

What is the new break-even point after implementing your solution?                                                     

What is the maximum income the company can make after implementing your solution? Is this enough profit to justify going into business? Why or why not?                                                                                    

Prepare both an absorption costing income statement and a variable costing income statement to reflect your solution. State your assumptions about the number of units produced and the number sold.            

                                                                                                                                                                                                                                                                                                

  

Answer 1

Building	500000
Useful Life	40
Salvaga Value	25000
Property taxes each Year	3000
Depreciation (SLM)	11875	(500000-25000)/40
Screw Machine	150,000
Useful Life	20
Residual Value	0
Machine Production	17500
Depreciation (SLM)	7500	(150000/20)
Salary	115000	Salary of VP and COO
Fixed Cost	150000
Selling Price	25
Screws Cost per box	12	128*0.0625*1.50
Plastic Cost per box	0.3	32*0.0625*0.15
Wages	5	(20/60)*15
Total Variable Cost
	17.3
Contribution	7.7	(25-17.3)
The Break Even Poin	19480.51	(150000/7.7)