Overview of Main Points Here is what we know about Precision Worldwide, Inc. (PWI): Manufactures industrial equipment and parts for sale in numerous countries. Repair and replacement parts account for a substantial part of the company’s business with the replacement part in question, steel rings, occur in the machines manufactured only in PWI’s German plant, but can also be used on some competitor’s machines. This steel ring has an average normal life of about 2 months. These individual rings are replaced as they wear out and recently competition has increased and now a competitor has entered the market with a superior and less expensive plastic ring that can replace the steel ring. The general manager of the German plant, Hans Thorborg has been considering the introduction of a similar plastic rings as a substitute for the steel rings. o There is a lot of potential for this product in this market because there is a lower manufacturing cost and a greater durability compare to steel rings. o The company is wondering if it is worth to shift from steel rings to plastic rings, but there are a lot of facts that they need to consider. o There are conflicting views concerning the future of the steel rings departments if they should change to plastic rings in order to acquire competitive advantage in this market and what will they do with the special steel after they have implemented the new product.
A decision must be made as whether to start producing the plastic parts or continue with the steel rings. The decision focuses on three key issues involves, doing incremental analysis of what amount of overhead, materials, and direct labor are relevant in making the decision to produce the new part. Information supplied from PWI’s cost accounting department in case study: Title Material Direct Labor Overhead Departmental Administrative Total 100 Plastic Rings 17.65 65.50 131.00 65.50 279.65 100 Steel Rings 321.90 196.50 393.00 196.50 1107.90
Some concerns for the company: There may be a cost of scrapping unused manufactured steel rings. There may be a cost of scrapping unused steel stock. The company may alienate customers that learn later that a superior plastic ring existed and the company did not offer it to them. The company may not enter the plastic ring market soon enough, or at all, and could lose existing or potential customers. The lifespan of the plastic ring versus the steel ring. There may be an opportunity costs for producing the plastic ring.
Scenarios Scenario #1: Sell steel rings only and do not sell plastic rings at all.
Assumptions Produce/sell steel rings only 70% production of steel during the off-peak months of Oct/Nov/Dec Sales price=$1350/100 rings (13.5/ring) Sales volume=690/week (2760/month) Table A for cost Table A Material Direct labor a Overhead Departmental Administrative Total (cost) Total (cost/ring) 100 Plastic Rings $ 17.65 65.50 131.00 65.50 $279.65 $2.80 1 Plastic Ring 0.1765 0.655 1.31 0.655 2.7965 $0.03 100 Steel Rings $321.90 196.50 393.00 196.50 $1,107.90 $11.08 1 Steel Ring 3.219 1.965 3.93 1.965 11.079 $0.11
In this scenario, the company will only produce/sell steel rings. 70% of the production of steel during the off-peak months occurred from October through December 2004. The
sales price was $1,350/100 rings ($13.50 per steel ring). The sales volume is $690 per week or $2,760 per month. Scenario #2: Sell only steel rings until plastics rings are ready for the market. Thereafter, sell only plastic rings and scrap all remaining steel rings and steel inventory (sunk cost). Assumptions Produce/sell plastic rings only 70% production of plastic during the off-peak months of Oct/Nov/Dec Sales price=$1350/100 rings (13.5/ring) Sales volume=690/week (2760/month) Table A for cost Book value of steel=$390,000; Cost of steel=$110,900; $279,100 write-off in May 2004 $7,500 cost to switch to plastic incurred in May 2004 Table A 100 Plastic Rings $ 17.65...
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