The Webster Corporation is a manufacturer of an electronic circuit board called the EC. which it...

  

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The Webster Corporation is a manufacturer of an electronic circuit board called the "EC". which it sells in the intermediate market. The following information is available about the EC (revenue and costs are provided on a per unit basis): Revenue Manufacturing costs: Material Labour Manufacturing overhead Total Manufacturing costs Annual volume, in units Plant capacity $25.00 10.00 20.00 24,000 24,000 $80.00 $55.00 Demand for the product is such that the plant operates 3 shifts per day, five days per week, or approximately 2,000 machine hours per shift per year. The $10.00 per unit labour cost represents the cost of the employee to run the machine (MI) and the cost of the inspector. Machine operators are paid $30.00 per hour. Inspectors are paid $10.00 per hour. Manufacturing overhead costs are approximately 40% fixed, based on operating the plant at full capacity. Overhead is allocated based on labour hours. Webster is considering the purchase of a new machine, M2 that has a capital cost of $300,000. This machine would produce a second product, the Super EC (SEC). The product would use the EC as its base, and then the new equipment would add advanced circuitry. The demand for the SEC is increasing, but Webster would be the dominant producer in the field. The product is distinct from the EC and the demand for that product would not change. Company management estimates that revenue for the new product will be $212.00 per unit. It will take twice as long, in terms of labour hours, to produce a unit of SEC on M2 as it does to produce a unit of EC on MI, but inspection time will remain the same. Variable overhead costs on the M2 are expected to be 25% higher than on MI. In addition to the EC board, $65.00 of materials will be added to complete the SEC. Webster plans to operate the M2 on the same basis it operates M1. If the demand for the product is sufficient, M2 would operate 6,000 machine hours per year. There will be no increase in fixed costs. All administrative costs are considered fixed. Sales commissions equal 5% of sales on the EC and it is anticipated that this commission rate would apply to the SEC as well. The new machine is classified as a class 8 asset for tax purposes. The CRA requires that assets in this class be written off using the declining balance method at a CCA rate of 20%. Company management is uncertain, however, as to the demand for the SEC. They have forecast the demand as follows Year 1 Year 2 Years 3-5 6,000 units 10,000 units 12,000 units 6,000 units 10,000 units 12,000 units 10,000 units 12,000 units Incremental Volume Probability .6 3 .1 .3 .6 .l .3 .7 It is anticipated that the machine will have a useful life of 5 years, after which it will be sold for $25,000. The CCA class will remain open. The company's combined corporate tax rate is 40% and it requires a 14% return, after tax, on projects with the level of risk associated with the SEC. The vice president of marketing has indicated that unless the M2 is purchased, the company's ability to compete in the target market segment will be impeded within five years. She feels the company has an opportunity to become a market leader in the field. Required: Prepare a report to the president. The report should include a supported recommendation for the proposed acquisition of M2, as well as any relevant qualitative issues. The Webster Corporation is a manufacturer of an electronic circuit board called the "EC". which it sells in the intermediate market. The following information is available about the EC (revenue and costs are provided on a per unit basis): Revenue Manufacturing costs: Material Labour Manufacturing overhead Total Manufacturing costs Annual volume, in units Plant capacity $25.00 10.00 20.00 24,000 24,000 $80.00 $55.00 Demand for the product is such that the plant operates 3 shifts per day, five days per week, or approximately 2,000 machine hours per shift per year. The $10.00 per unit labour cost represents the cost of the employee to run the machine (MI) and the cost of the inspector. Machine operators are paid $30.00 per hour. Inspectors are paid $10.00 per hour. Manufacturing overhead costs are approximately 40% fixed, based on operating the plant at full capacity. Overhead is allocated based on labour hours. Webster is considering the purchase of a new machine, M2 that has a capital cost of $300,000. This machine would produce a second product, the Super EC (SEC). The product would use the EC as its base, and then the new equipment would add advanced circuitry. The demand for the SEC is increasing, but Webster would be the dominant producer in the field. The product is distinct from the EC and the demand for that product would not change. Company management estimates that revenue for the new product will be $212.00 per unit. It will take twice as long, in terms of labour hours, to produce a unit of SEC on M2 as it does to produce a unit of EC on MI, but inspection time will remain the same. Variable overhead costs on the M2 are expected to be 25% higher than on MI. In addition to the EC board, $65.00 of materials will be added to complete the SEC. Webster plans to operate the M2 on the same basis it operates M1. If the demand for the product is sufficient, M2 would operate 6,000 machine hours per year. There will be no increase in fixed costs. All administrative costs are considered fixed. Sales commissions equal 5% of sales on the EC and it is anticipated that this commission rate would apply to the SEC as well. The new machine is classified as a class 8 asset for tax purposes. The CRA requires that assets in this class be written off using the declining balance method at a CCA rate of 20%. Company management is uncertain, however, as to the demand for the SEC. They have forecast the demand as follows Year 1 Year 2 Years 3-5 6,000 units 10,000 units 12,000 units 6,000 units 10,000 units 12,000 units 10,000 units 12,000 units Incremental Volume Probability .6 3 .1 .3 .6 .l .3 .7 It is anticipated that the machine will have a useful life of 5 years, after which it will be sold for $25,000. The CCA class will remain open. The company's combined corporate tax rate is 40% and it requires a 14% return, after tax, on projects with the level of risk associated with the SEC. The vice president of marketing has indicated that unless the M2 is purchased, the company's ability to compete in the target market segment will be impeded within five years. She feels the company has an opportunity to become a market leader in the field. Required: Prepare a report to the president. The report should include a supported recommendation for the proposed acquisition of M2, as well as any relevant qualitative issues.