Question

CompuBright manufactures a product called the BlueBerry 200. This the firm’s main product and accounts for a significant portion of profits. Last week, CompuBright was approached by LowValue, an online retailer, who offered to purchase a private label version of the BlueBerry 200. This product would be called the StrawBerry. It would have most of the same functions as the BlueBerry 200 in addition to some minor cosmetic differences.

The LowValue offer had a number of issues that gave the president some concern. These included:

·         Lower price than the BlueBerry 200

·         Significant volume (27% of manufacturing capacity)

·         Small cost for one-time design and setup

·         Significant investment in inventory is required

·         LowValue takes longer than average to pay vendors

·         Accepting the order would exceed manufacturing capacity, but LowValue has indicated it is an all or nothing deal

Information about these issues and other data are provided below. The president has asked you to provide a recommendation on the LowValue offer.

Required:

1.       Calculate the incremental profit from accepting the LowValue offer.

2.       Calculate the investment in working capital.

3.       Calculate a simple ROI for the deal.

Cost Structure Bluberry 200

Per unit costs

Direct materials - $8

Direct Labor - $4.50

Fixed Manufacturing OH- $8

Full Manufacturing costs of blueberry200 is $20.50

The LowValue offer

Quantity (annual sales) 35,000 Price $17    One-time design and setup cost- $2,800

Cost Structure Starwberry

Direct marerials / unit costs- $7.50 Direct Labor/ unit costs- $4.00

Low value requires quick access to inventory and takes longer than normal to pay vendors

Incremental FG inventory (# units) - 10,000

Collection period (# days) - 60

Income tax rate- 30%

Answer 1

Calculation of incremental profit:

Alternative -1 Altemative -2

variable cost:

Cost to buy from law value 17

Direct material 8 0

Direct Labour 4.50 0

Manufacturing overhead 8 0

Total Cost 20.50 17

Incremental Profit (20.50-17)= 3.50 per unit

Total incremental profit = 35000*3.50=122500

2.

investment in working capital

sales=35000*17=595000

collection period =60 days

595000*60*/365=97808

Investment in wc= Debtor +stock

97808+10000*7.5

=172808

3.

simple ROI =Gains-Investment/investment

=incremental Gains=35000 *3.5=122500

Tax 30%=36750

gain = 122500-36750=85750