The Microetching Department of Special Electric Company manufactures products A and B. Product A is sold directly
Question:
The Microetching Department of Special Electric Company manufactures products A and B. Product A is sold directly to industrial customers. Product B is a home-use version of Product A that is sold to retailers.
The electrocyber machine used by Microetching Department broke down on December 31. It was clear that this machine was no longer usable. The Maintenance Department did not feel that they could return the machine to reasonable operating efficiency. Upon receiving this information, the manager of the Microetching Department immediately made a request to corporate management for the $1,100,000 that would be required to acquire and install a new machine. However, corporate management responded by requesting a complete analysis of the acquisition giving specific consideration to dropping the Microetching Department and selling the company’s patent on the electrocyber machine. The company has received an offer of $1,700,000 for this patent.
Investigation of the situation has provided the following information:
The old machine cost $750,000 three years ago and is being depreciated over five years on a straight-line basis for financial reporting purposes. As a broken-down machine, it can be sold for $40,000, but it will cost $20,000 to remove it from the premises.
The patent was acquired from another company three years ago for $1,600,000 and is being amortized (i.e., written off as an expense) straight-line over its life for reporting purposes. The patent has a remaining life of five years.
If the department is closed, the manager would be made assistant manager of a larger department. In his new post, he would receive a salary of $85,000, which is $4,000 less than the company would have to pay to fill the assistant manager’s position with an equally-competent outsider.
The new machine would reduce the annual maintenance cost to $60,000. The $1,100,000 acquisition price would be depreciated straight-line over the five year expected life of new machine. An expected salvage value of $100,000 would be recognized in calculating depreciation for financial reporting purposes.
The space-related costs consist of allocated charges for building maintenance (50%), depreciation (30%), and property taxes (20%). The department uses 6,500 square feet of space, and the average annual cost per square foot for operating the building is $50. If the department is eliminated, this space will be left idle for 2023, but at the end of that year, demand for space by other departments will have increased sufficiently to require use of this space, if available, or some other similar space. Similar space in an adjacent building can be rented externally at an annual cost of about $80 per square foot. Special Electric has entered into a contract to move all of its operations to a new facility on January 1, 2025. The new facility will be large enough to easily accommodate all of Special Electric’s operations. Because the facility is in a remote location, there is no prospect of renting out surplus space.
The departmental income statement for the year just ending is:
Microetching department
Income statement for the year ended December 31, 2022
| Product | A | B | |
|---|---|---|---|
| Sales (units) | 2000 | 2000 | |
| Sale (orders) | 2000 | 500 | |
| Sales | 3,750,000 | 1,000,000 | 4,750,000 |
| Variable Manufacturing Costs (1) | 2,600,000 | 400,000 | 3,000,000 |
| Variable Selling Costs (2) | 600,000 | 150,000 | 750,000 |
| Total Variable Costs | 3,200,000 | 550,000 | 3,750,000 |
| Contribution Margin | 1,000,000 | ||
| Other Costs | |||
| Machine Depreciation | 150,000 | ||
| Patent amortization | 200,000 | ||
| Manager’s salary | 75,000 | ||
| Machine maintenance | 100,000 | ||
| Space-related costs | 325,000 | ||
| Total Other Costs | 850,000 | ||
| Departmental Income | $ 150,000 |
(1) These costs vary with the number of units produced.
(2) These costs vary with the number of orders processed.
To simplify calculations, ignore income taxes. If you choose to use Net Present Value Analysis, assume the appropriate discount rate is 10% per annum.
We will discuss the following questions in class:
1. From the shareholders’ perspective, should the Microetching Department cease operations or should a new electrocyber machine be purchased?
2. Suppose the individual making the decision is compensated on the total of Departmental Incomes for all of the Special Electric Departments after gain or loss on the disposal of assets. The decision maker will retire at the end of 2023. What decision do you think that person would favor? Why?
3. Assume the electrocyber machine is replaced. Both Product A and Product B must be processed in the electrocyber machine. The machine is available for processing for 5,000 hours per year. Each unit of Product A requires 2 hours in the electrocyber machine. Each unit of Product B requires 0.5 hours in the electrocyber machine. A one-time only special order is received for 100 units of Product B at $300 per unit. Budgeted sales (units and dollars) and costs for 2023 are identical to 2022 actual costs. Variable selling costs attributable to this order would amount to $300. Should this order be accepted? Suppose the decision to accept this order lies with the decision maker described in question 2. What decision do you think that person would favor? Why?
Expert Answer:
1 To determine this we should compare the costs and benefits of both options Costs of Ceasing Operations Machine Sale 40000 sale price 20000 removal c... View the full answer
