Faith Patel has worked as the plant manager of Murdock Corporation, a large manufacturing company, for 10 years. The company produces stereo CD players for automotive vehicles and sells them to some of the largest car manufacturers in the country. Ms. Patel has always toyed with the idea of starting her own car stereo manufacturing business. With her experience and knowledge, she is certain that she can produce a superior stereo at a low cost. Ms. Patel’s business strategy would be to market the product to smaller, more specialized car manufacturers. Her potential market is car manufacturers who sell at a lower volume to discriminating customers. She is confident that she could compete in this market that values low-cost quality production. She would not compete with Murdock or the other large stereo producers that dominate the market made up of the largest automotive producers.
Ms. Patel already has firm orders for 800 stereos from several automotive producers. Based on the contacts that she has made working for Murdock, Ms. Patel is confident that she can make and sell 2,000 stereos during the first year of operation. However, before making a final decision, she decides to investigate the profitability of starting her own business. Relevant information follows.
Components from suppliers............$26.00 per stereo
Assembly labor................$10.00 per hour
Rent of manufacturing buildings........$7,000.00 per year
Utilities.................$240.00 per month
Sales salaries...............$480.00 per month
Depreciation of equipment ..........$1,600.00 per year
Labor..................3 hours per stereo
During the first year, Ms. Patel expects to be able to produce the stereos with only two production workers and a part-time salesperson to market the product. Ms. Patel expects to devote her time to the administrative aspects of the business and to provide back-up support in the production work. She has decided not to pay herself a salary but to live off the profits of the business.

a. Classify each cost item into the categories of direct materials, direct labor, and manufacturing overhead.
b. Classify each cost item as either variable or fixed.
c. What is the cost per stereo if Ms. Patel’s company produces 800 units per year? What is the unit cost if the company produces 2,000 units per year?
d. If Ms. Patel’s job presently pays her $12,000 a year, would you recommend that she proceed with the plans to start the new company if she could sell stereos for $92 each?

  • CreatedFebruary 07, 2014
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