Merton Truck Co

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Case Analysis: Merton Truck Company
Linear programming techniques can be used to not only determine the best production mix, but also to provide clues and data suggesting ways to improve profits. In 1988, Merton Truck Company was searching for ways to increase profits and ultimately its poor financial performance. Options being considered included changing their product mix by either removing or adding a product line, or renting capacity. In the following pages, the product mix and capacity options considered by Merton are evaluated, other factors and alternatives are discussed, and final recommendations are provided. Product Mix

Based on the financials in 1988, Merton’s president suspected that discontinuing their Model 101 would result in stronger financial performance. With unit costs of $40,205 (including fixed overhead) and a sales price of $39,000, each sale of Model 101 resulted in a $1,205 loss. However, the president did not consider that fixed overhead (OH) was being allocated across all units, and the discontinuation of Model 101 would increase the overhead applied to Model 102. In reality, the $8.6M in monthly fixed overhead exists regardless of the product mix and does not need to be allocated on a per unit basis to determine overall profit or financial performance. Therefore, fixed overhead was not considered until the end of each evaluation.

In order to evaluate any alternative, we need to compare to current profit. Utilizing the data from Tables B and C to obtain production costs per unit as well as fixed overhead, Merton is currently making a profit of $1.9M (Exhibit 1A).

Since it was the specific request of the president, the impact of discontinuing Model 101 was evaluated. The first step was to determine the capacity of producing only Model 102, which is as follows based on Table A:

Engine Assembly4,000 hours / 2 hours per unit = 2,000 units
Metal Stamping6,000 hours / 2 hours per unit = 3,000 units
Model 102 Assembly4,500 hours / 3 hours per unit = 1,500 units The resulting capacity of 1,500 units is the same as the current production level, so it was suspected immediately that discontinuing Model 101 would likely have a negative result. Without an increase in sales, discontinuing Model 101 would only result in increasing the fixed costs for Model 102 without increasing the revenue. As seen in Exhibit 1B, this would indeed result in a $1.1M monthly loss for Merton. This is a phenomenon known as the death spiral, when the discontinuation of a seemingly unprofitable product causes otherwise profitable products to become unprofitable. Merton should continue to use that extra capacity to produce Model 101 to generate additional revenue and help absorb costs.

The impact of making only Model 101was evaluated by determining the capacity using Table A:
Engine Assembly4,000 hours / 1 hour per unit = 4,000 units
Metal Stamping6,000 hours / 2 hours per unit = 3,000 units
Model 101 Assembly5,000 hours / 2 hours per unit = 2,500 units As shown in Exhibit 1C, producing 2,500 units of Model 101 results in a $1.1M loss. However, since the bottleneck is the Model 101 Assembly, additional capacity remains to produce Model 102 units:

Engine Assembly1,500 hours remaining / 2 hours per unit = 750 units
Metal Stamping1,000 hours remaining / 2 hours per unit = 500 units
Model 102 Assembly4,500 hours / 3 hours per unit = 1,500 units Exhibit 1D shows that producing 500 units of Model 102 results in a $1.4M profit; however, Merton is still better off in its current situation.

In the current analysis, it is assumed that Model 102 Assembly cannot be used for Model 101, a logical assumptionsince Merton specifies the department where Model 103 will be made. However, if Model 102 Assembly can be used for Model 101, the bottleneck then becomes Metal Stamping at 3,000 units x $3,000 CM = $9.0M - $8.6M = $0.4M profit. In a similar fashion, the ability to use Model 101...
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