question archive Question 1 In the context of 'Vision 2027', the new management is considering purchase of environmentally friendly equipment

Question 1 In the context of 'Vision 2027', the new management is considering purchase of environmentally friendly equipment

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Question 1

In the context of 'Vision 2027', the new management is considering purchase of environmentally friendly equipment. Based on the information given in Appendix Q1.1 Below , answer the following question.

 

a. Using the information in Table 1, and your knowledge of relevant costs, calculate the increase/decrease in operating profit for the company if the fixed-wing drones were discontinued.

 

b. For each of the four fixed overheads, give a reason why you decided in (a) that the overhead is relevant or irrelevant.

 

  • c. Based on your analysis of relevant and non-relevant costs:

i. Amend the operating statement in Table 1 to provide the total profitability of the drones as well as the profitability of each drone.

 

ii. Explain the main reason for the change you propose in (c) (i) above.

 

d. Using the information in Table 2, and your knowledge of relevant costs, calculate the difference in profit over the next five years between keeping and replacing the old machine.

 

e. Evaluate the response of the managing director to the proposed new machine.

 

 

 

Appendix Q1.1: Proposal to replace equipment

 

Mr. Jordan plans to introduce new environmentally friendly technology to manufacture drones for the toy market. The current product ranges consist of three types of drones manufactured from two specialist machines in a UK factory that produces no other toys.

The following information on sales and expenses for the past month has now become available.

 

Table 1: Operating statement

    Drones
    Total Fixed-wing Fixed-wing hybrid Multi-rotor
    £ £ £ £
Sales   845,000 180,000 420,000 245,000
Less: variable expenses 354,000 93,000 160,000 101,000
Contribution 491,000 87,000 260,000 144,000
Less: fixed overheads        
  Marketing 102,000 18,000 58,000 26,000
  Deprecation of equipment 116,000 36,000 48,000 32,000
  Line supervisors' salaries 34,000 11,000 12,000 11,000
  Factory overheads 169,000 36,000 84,000 49,000
  Total fixed overheads 421,000 101,000 202,000 118,000
Net operating profit (loss)

Total70,000

Total(14,000)

Total58,000

Total26,000

 

Mr Jordan is concerned about the losses shown by the fixed-wing drones and wants a recommendation as to whether the line should be discontinued.

The following information is relevant to the fixed overhead figures above.

  1. The two specialist machines used to produce each of the three drones currently have no resale value.
  2. The company has no other use for the capacity now being used to produce fixed-wing drones.
  3. If the fixed-wing drones were discontinued, both line supervisors responsible for its manufacture would no longer need to be employed by the company.
  4. The marketing expense for each line of drones is exclusively for those drones.
  5. Factory overheads are general and fixed common costs that are allocated based on sales.

Proposal of new machine and other new information

After consultation with the production manager, Mr Jordan is considering the purchase of a new machine. The new machine will comply with new environmentally friendly technology and will cut scrap and rework rates (the cost of remedying manufacturing problems), resulting in substantial savings in materials and labour costs. A production manager has gathered the following information concerning the old machine and the proposed new one.

 

Table 2: Information for replacing old machine

Old machine       Proposed new machine  
Original cost   £125,000   List price new   £150,000
Remaining book value £90,000   Expected life   5 years
Remaining life   5 years   Disposal value in five years £0
Disposal value now £50,000   Annual variable operating expenses £220,000
Disposal value in five years £0   Annual revenue from sales £500,000
Annual variable operating expenses £265,000          
Annual revenue from sales £500,000          

 

During the initial discussion about the proposal to replace the machine, the first response, from the Board of Directors was that the company had already made an investment in the old machine, so the business had no choice until their investment has been fully recovered as it is now just a 'sunk cost'. Mr Jordan went on to say that a further reason for not purchasing the new machine was that the disposal of the old machine would result in a 'loss' of £40,000.

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