Merton Truck Company

Merton Truck Company1 Top Management of Merton Truck Company is planning to revisit the current product mix of the company involving two models of trucks M101 and M102 as the President of the company feels that M101 truck is not contributing to company’s profit. She also feels that purchasing engines from an outside supplier may be a good option as it eases the capacity problem in the engine assembly department. Manufacturing of the trucks are carried out in a three stage process involving engine assembly, metal stamping and model assembly. The first two activities are common for both the models while model assemblies are carried out in two separate departments, one for each model. Data on machine hour requirements for each truck model in each department and monthly machine hour availability in the departments are given in Table 1 below. Assume there are no demand constraints for sale of trucks. Table 1 Machine hour requirements and availability Department Machine hours required Total machine per truck hours available per month Model 101 Model 102 Engine Assembly 1.0 2.0 4000 Metal Stamping 2.0 2.0 6000 Model 101 2.0 --5000 assembly Model 102 --3.0 4500 assembly During the past six months the company had produced 1000 M101 and 1500 M102 trucks per month. At this level of production Model 102 assembly and engine assembly were working at full capacity while the other two departments of metal stamping and M101 assembly were operating at only 83.3% and 40% of capacity respectively. Table 2 gives standard cost at this level of production while Table 3 gives details on overhead costs Table 2 Standard Product Costs Model 101 $24,000

Direct materials Direct Labor

Overhead

Model 102 $2,0000

Engine Assembly Metal Stamping Final Assembly

1,200

2,400

800

600

Engine Assembly

2,525

2,000

$ 4,000

1,500

(see

Table 3)

1

4,850

$4,500

Metal Stamping Final Assembly

3,480 6,200

3,080 $ 12,205 $40,205

Table 3 Overhead Budget during last six months Department Total Fixed Overhead per Overhead per month month ($ Millions) ($ Millions) Engine Assembly 9.8 1.7 Metal Stamping 8.1 2.7 Model 101 6.2 2.7 assembly Model 102 5.25 1.5 assembly 29.35 8.6

3,500

$11,430 $35,930

Variable Overhead/unit Model Model 101 102 2,100 4,000 2,400 2,000 3,500 ---

2,500

$8,000

$8,500

The sales price of M101 truck is $39,000 while for M102, it is $38,000. Sales manager feels that (from Table 2), truck M101 is making a loss of $1205 for every truck sold and recommends discontinuation of the model. But the cost accountant feels that the problem is in the accounting system followed. “We are trying to absorb the entire fixed overhead of M101 assembly over only 1000 trucks. We would be better off increasing production of M101 trucks, cutting back if necessary on Model 102 production” he opined. Production manager on the other hand has a different view. “We can relieve the capacity problem in engine assembly by purchasing M101 or M102 engines from an outside supplier. We will furnish necessary materials and engine components and reimburse the supplier for labor and overhead. This way we can increase M101 production without cutting back M102 production” What should they do?

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Questions for Discussion

1. a. Find the best product mix for Merton b. What would be the best product mix if engine assembly capacity were raised by one unit (i..e from 4000 to 4001 machine-hours) What is the extra unit of capacity worth? c. Assume that second additional unit of engine assembly capacity is worth as the first. Verify that is capacity were increased to 4,100 machine-hours, then the increase in contribution would be 100 times of that in part (b) d. How many units of engine assembly can be added before there is a change in the value of an additional unit of capacity? 2. Should Merton pursue the suggestion of production manager to renting engine assembly capacity from an outside supplier? If yes, what is the maximum rent it should be

willing to pay for a machine-hour of engine assembly capacity? What is the maximum number of machine hours it should rent? 3. Merton is considering introduction of a new truck M103 each unit of which would give a contribution of $ 2000. The total engine assembly would be sufficient to produce 5000 units of m103 per month and total metal stamping capacity would be sufficient to produce 4000 units of Model M103. The new truck would be assemble in M101 assembly department, each model M102 truck requiring only half as much time as M101 truck a. Should Merton produce M103 trucks? b. How high would be the contribution on each M103 truck has to be before it became worthwhile t produce the new model? 4. Engines can be assembled on overtime in the engine assembly department. Suppose, production efficiencies do not change and 2,000 machine hours of over time capacity is available in engine assembly department. Direct labor costs are higher by 50% for overtime production. While variable overhead would remain the same, monthly fixed overhead in the engine assembly department would increase by $0.75 million. Should Merton assemble engines on overtime? 5. A market study revealed that M101 trucks have a better “brand image” in the market and discontinuing same may not be good for the company in the long run. What should be the optimal product mix that maximizes the monthly contribution, if it is necessary to ensure that number of M101 trucks produced per month is at least three times that of M102 trucks produced, to enhance the brand image?