Relevant costs, capital budgeting, strategic decision. (M. Porporato, adapted) Wilcox is a family-owned company that has been making microwaves for almost 20 years. The company’s production line includes ten models, ranging from a basic model to a deluxe stainless steel model. Most of its sales are through independently owned retailers in medium-sized towns in central Canada, giving the microwaves an image of high quality and price. However, industry sales have been stagnant and those of Wilcox have been falling in the past two years due to the Asian brands. Currently Wilcox sells 75,000 units per year at an average price of $120 each with variable unit costs of $60 (of which materials is $30). As a result Wilcox is operating its plant at about 75% of a one-shift capacity, although in their “golden years” in the early 1990s they were operating at 75% of a two-shift capacity.
In the spring of 2013, Oh Mart, a chain of large supermarkets, approached Wilcox’s CEO and asked about the possibility of producing microwaves for them. The microwaves will be sold under the Oh Mart house brand, called Top Line.
They are offering a five-year con- tract that could be automatically extended on a year-to-year basis, unless one party gives the other at least three months’ notice that it does not wish to extend the contract. The deal is for 24,000 units per year with a unit price of $90 each. Oh Mart does not want title on a microwave to pass from Wilcox to Oh Mart until the microwave is shipped to a specific Oh Mart store. Additionally Oh Mart wants the Top Line microwaves to be somewhat different in appearance from Wilcox’s other microwaves. These requirements would increase Wilcox’s purchasing, inventorying, and production costs.
In order to be able to give an answer to Oh Mart, knowing that they had no room to negotiate, Wilcox managers gathered the following information:
1. First-year costs of producing Top Line microwaves:
883Capital Budgeting: Methods of Investment AnalysisMaterials (includes items specific to Oh Mart models)........................ $40
Labour (same as with regular microwaves).............. $20
Overhead at 100% of labour (50% is variable; the 100%
rate is based on a volume of 100,000 units per year) ........... $20
Total unit cost.......................... $80
2. Related added inventories (the cost of financing them is estimated to be close to 15% per year):
Materials:........... two-month supply (a total of 4,000 units)
Work in process:........ 1,000 units, half completed (but all materials for them issued)
Finished goods:......... 500 units (awaiting next carload lot shipment to an Oh Mart central warehouse in Concord, Ontario)
3. Impact on Wilcox’s regular sales. Wilcox’s sales over the next two years are expected to be about 75,000 units a year if they forgo the Oh Mart deal, based on the CEO estimates after launching a new “top of the line” microwave. If Wilcox accepts the deal, it would lose about 5,000 units of theregular sales volume a year, since their retail distribution is quite strong in Oh Mart market regions. These estimates do not include the possibility that a few of Wilcox’s current dealers might drop their line if they find out that Wilcox is making microwaves for Oh Mart with a lower selling price.