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This is just part of the question which reads as follows:
Stay Clean manufactures and sell a small range of kitchen equipment which are Dishwasher (DW), a Washing Machine (WM), and Tumble Dryer(TD). TD is an old design and some time generated negative contribution.
Note
1. The normal selling pricing, annual sales volumes and total variable costs for the three products are as follows:DW WM TD
s.p./unit 200 350 80
Material /unit 70 100 50
Labour/unit 50 80 40
Contribution/unit 80 170 -10
Annual Sales 5000 units 6000 units 1200 units2. It is thought that some of the customers that buy a TD also buy a DW and WM. It is estimated that 5% of the sales of WM and DW will be lost if the TD ceases to be produced.
4. Stay Clean operates a just in time policy and so all material cost would be saved on the TD for 12 months if TD production ceased now. Equally the material costs relating to the lost sales on the WM and the DW would also be saved. However, the material supplier has a volume based discount scheme in place as follows:
Total Annual Expenditure ($) Discount
0-600,000 0%
600,001-800,000 1%
800,001-900,000 2%
900,001-960,000 3%
960,000 and above 5%Stay Clean uses this supplier for all its materials for all the products it manufactures. The figures given above in the cost per unit table for material cost per unit are net of any discount Stay Clean already qualifies for.
THE REQUIREMENT OF THE QUESTION STATES:
Calculate whether or not it is worthwhile ceasing to produce the TD now rather than waiting 12 months.MY QUESTION IS CAN SOMEONE EXPLAIN THE APPROACH STEP BY STEP ON HOW THE EXAMINER ARRIVED AT THE SUPPLIER PAYMENTS SAVED OF $88,500. INCORPORATING THAT DISCOUNT TABLE..
THANKS
First of all, if they stop TD then they save the material on TD which saves them 1200 units x $50 = $60,000.
They will also save material on the other two products, because they will be making 5% less of them. It is here where there is a bit of a problem 🙂
At the moment they are spending in total on DW and WM, $950,000.
(DW = 5000 units at $70; plus WM = 6000 units at $100)However, the are currently getting a discount of 5% (because when you add in the purchases they are currently buying for TD they are spending more than 960,000)
So….although they are paying $950,000, the full price before discount would have been $1,000,000. ($1M less 5% is $950,000)
In future they will only be buying for DW and WD and will be buying 5% less, and so the full price of everything they are buying will be 95% of $1,000,000 which is $950,000. This will only get them a discount of 3% and so the actual cost will be 97% of $950,000 = $921,500.
So…..for DW and WD, the currently pay $950,000 in total but in future will pay $921,500 in total – a saving of $28,500.
Add this to the amount saved on TD of $60,000, and the total saving is $88,500.
🙂
Hi John,
I was just working through this question. I have had a look at the explanation above but I am a bit confused as to why they exclude material cost from the lost contribution working?
I would of thought this would of been a separate working.
Many thanks if you could help me out!
ANSWER FROM DEC 2009 F5
a) The relevant costs of the decision to cease the manufacture of the TD are needed:
Cost or Revenue Working reference Amount ($)
Lost revenue Note 1 (96,000)
Saved labour cost Note 2 48,000
Lost contribution from other products Note 3 (118,500)
Redundancy and recruitment costs Note 4 (3,700)
Supplier payments saved Note 5 88,500
Sublet income 12,000
Supervisor Note 6 0
––––––––
Net cash flow (69,700)
––––––––
Conclusion: It is not worthwhile ceasing to produce the TD now.
Note 1: All sales of the TD will be lost for the next 12 months, this will lose revenue of 1,200 units x $80 = $96,000
Note 2: All normal labour costs will be saved at 1,200 units x $40 = $48,000
Note 3: Related product sales will be lost.
This will cost the business 5% x ((5,000u x $150) + (6,000u x $270)) = $118,500 in contribution (material costs
are dealt with separately below)
Note 4: If TD is ceased now, then:
Redundancy cost ($6,000)
Retraining saved $3,500
Recruitment cost ($1,200)
––––––––
Total cost ($3,700)
Note 5. Supplier payments:
DW ($) WM ($) TD ($) Net cost Discount Gross cost
($) level ($)
Current buying cost 350,000 600,000 60,000 1,010,000 5% 1,063,158
Loss of TD (60,000) (60,000) 5% (63,158)
Loss of related sales at cost (17,500) (30,000) (47,500) 5% (50,000)
New buying cost 921,500 3% 950,000
Difference in net cost 88,500
Note 6: There will be no saving or cost here as the supervisor will continue to be fully employed.
An alternative approach is possible to the above problem:
Cash flow Ref Amount ($)
Lost contribution – TD Note 7 12,000
Lost contribution – other products Note 8 (71,000)
Redundancy and recruitment Note 4 above (3,700)
Lost discount Note 9 (19,000)
Sublet income 12,000
Supervisor Note 6 above 0
––––––––
Net cash flow (69,700)
––––––––
Note 7: There will be a saving on the contribution lost on the TD of 1,200 units x $10 per unit = –$12,000
Note 8: The loss of sales of other products will cost a lost contribution of 5% ((5,000 x $80) + (6,000 x $170)) = $71,000
Note 9
DW WM TD Total (net) Discount Total gross
Current buying cost 350,000 600,000 60,000 1,010,000 5% 1,063,158
Saved cost (17,500 (30,000) (60,000)
New buying cost 332,500 (570,000) 0 902,500 5% 950,000
921,500 3% 950,000
Lost discount (19,000)
(b) Complementary pricing
Since the washing machine and the tumble dryer are products that tend to be used together, Stay Clean could link their sales
with a complementary price. For example they could offer customers a discount on the second product bought, so if they buy
(say) a TD for $80 then they can get a WM for (say) $320. Overall then Stay Clean make a positive contribution of $130
(320 + 80 – 180 – 90).
15They exclude the material because of the discount problem – this has been dealt with separately.
Why is 902500 taken for a discount of 5% when in the question the say 3%.cud u explain the logic sir
Because the 902,500 was calculated using the prices given, which are net of a 5% discount. That is why it is then calculated what the price before discount would be, and the discount then recalculated at 3% to find the actual amount paid.
Hi John,
In the alternative approach, why was saved labour cost not included in the calculation?
An alternative approach is possible to the above problem:
Cash flow Ref Amount ($)
Lost contribution – TD Note 7 12,000
Lost contribution – other products Note 8 (71,000)
Redundancy and recruitment Note 4 above (3,700)
Lost discount Note 9 (19,000)
Sublet income 12,000
Supervisor Note 6 above 0Thanks,
Maria
I have confusion in the same question note 3
Related to the product sale will be lost
This will cost the business 5%(5000u*150)+(6000u*270)= 118500 how they have taken the price $ 150 and $270As is stated in the answer, it is the contribution that is being lost, and they have taken the contribution before the material cost (because the affect on the material cost is dealt with separately in the answer).
So for DW, the contribution ignoring the material cost is 200 – 50 = 150.
For WM, the contribution ignoring the material cost is 350 – 80 = 270.
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