Reichard Maschinen, GmbH
Issue of the case
Facing the introduction of plastics rings by one competitor, Bruggeman, Reichard Maschinen, GmbH (RMG) needs to decide 1) whether they will start to produce plastic rings and 2) when to start the production, if needed.
1.Incremental cost analysis
For the short run, RM has the following three alternatives. We will propose to limit the time span of this analysis to 6 months and assume there will be no change in capacity to produce rings within this period. We will recommend to evaluate the following three options.
Alternative 1. Sell steel rings which are already in inventory and do not produce steel rings.
(They can continue to sell steel rings for 37 weeks with this inventory.)
Alternative 2. Produce next 34,500 steel rings. (They can sell steel rings for 87 weeks.
Alternative 3. Start to produce plastic rings in September.
(Throw away steel raw materials.
Incremental cost on alternative 1 (Sell steel rings which are already in inventory and do not produce steel rings.)
Because they will not incur any production cost and the finished goods to be sold are already in inventory, the incremental cost will be $0 as shown in the right table. One can also point out that the 70% of wages will be incurred during the summer, but it is common to the three alternatives and will not be included in the incremental costs.
Incremental cost on alternative 2 (Produce next 34,500 steel rings.)
With this alternative, RMG can finish the production during the summer slack season. They will incur the direct labor cost in this period and the wages that will additionally paid will be 30% of the regular wages. The variable OH cost is 80% of direct labor costs. The total incremental costs are as shown in the right table.
Incremental cost on alternative 3 (Start to produce plastic rings in September.)
Because RMG needs to prepare for the plastics production until September, the direct labor cost, as well as the material costs, will be fully incurred as estimated by the controller. For the short run, we assume no capacity expansion, so we will exclude the fixed OH costs estimated by the controller and include the additional fixed OH incurred by the acquisition of molds and tooling and the variable OH costs, i.e. 80% of labor costs.
To calculate the additional fixed OH, i. e. molds and tooling, we assume the useful life of this equipment is 5 years. One can also assume that the demand for the plastic rings will start with 10% of the current demand for steel rings.
Then the annual demand for the plastic rings will be calculated as follows. Annual demand for the plastic rings = 690units/wk * 53wks * 10%
The additional OH cost per 100 plastic will be calculated as follows; Cost per 100 units= (Acquisition cost/( useful life*annual demand )) * 100
The total incremental cost with this alternative will amount to $54.69 as shown in the right table.
Because when RMG do not sell plastic rings, they will lose 10% share. But when they do, they can gain this revenue. We will recommend to include this in the incremental revenue in alternative 3. Otherwise, one can include this revenue, in the opportunity cost of the first two alternatives. When we assume the sales price of $325 for both types of the rings, the comparison of the incremental profit is shown in the following table.
Decision based on the incremental analysis
As shown in the incremental analysis, alternative 1 will be the best decision for RMG for the short run.
Long term cost analysis
The decision based on the incremental cost analysis is that the company do not produce any rings. However, we strongly recommend to analyse the profitability of producing plastic rings in the long run, because the analysis above does not include all the costs that will be incurred in the long...