Answers to 2014Q3 LMS PDF

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Question 3

a) (i) Prepare a quantitative analysis that would help the company decide which watch models it should prioritise selling for the month of December, 2014. Determine the order of priority. (ii) How many units of each watch model should the company sell in December, 2014? (i) 

LO would have the lowest priority as its contribution margin per unit is negative

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Total machine hours required to fulfil SC and BV orders = 850 hours which is greater than the 700 machine hours available. Therefore Machine Hours is a constraint.

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Total labour hours required to fulfil SC and BV orders = 900 hours which less than the 1,000 labour hours available. Therefore, labour hours is NOT a constraint.

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Contribution margin per unit of constrained resource for SC: 120/0.3 = 400

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Contribution margin per unit of constrained resource for BV: 90 / 0.5 = 180

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Therefore it should prioritise selling SC, followed by BV and finally LO

(ii)

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2,000 units of SC will be sold since this model is top priority.

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Machine hours to produce 2,000 SC = 2,000 x 0.3hr = 600 hours; and leftover machine hours = 700 – 600 = 100 hour

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Units of BV sold = (100 / 0.5 hours) = 200 units.

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Units of LO: zero

b) What are two (2) additional factors that the company would also need to consider when deciding which models it should focus on selling in December 2014? Page 1 of 4

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Need to consider if customers who ordered SC also order BV and LO. If the answer is yes, then how likely those who do not get their order filled for LO and BV also stop buying SC from you.

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How important are the customers who ordered LO and BV? If they are important (e.g., due to expected large orders from them in the future), may decide prioritise the orders from these customers instead.

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Intangible benefits of selling a less profitable product – e.g., selling LO could help the company enhance its reputation because this particular model is of high quality.

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How does the decision to not produce a particular product affect employee morale

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Would it be possible to shift additional idle labour resources (100 hours) to do the work that the machines (constrained capacity) were doing?

Page 2 of 4

c) It turns out that the supplier of its watch-making machines is willing to lease the company an additional machine to make watches for the whole month of December if needed. The leased machine is able to operate for 150 hours per month. The leased machine also has different capabilities than the company’s existing machine. As a result, the leased machine hours required to make each of the models are as follows:  SC: 0.3 hours per watch  LO: 0.4 hours per watch  BV: 1.0 hours per watch Based on short-term quantitative factors alone, what is the lease payment that would cause the company to breakeven i.e., be indifferent between leasing and not leasing the machine for the month of December? 

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Leased machine can either be used to make SC or BV. Analysis 1: If make SC, then total units SC that the leased machine would be able to make = 150/0.3 hours = 500 units of SC. This 500 units of SC made by the leased machine would create 150 hours of spare capacity in the company’s machine. This would allow 150 hours / 0.5 = 300 units of BV to be made by the existing machine for which there is existing demand for. The relevant revenues from leasing the machine would be the contribution margin from selling the additional BV units since the demand for SC is totally fulfilled under both alternatives. The additional contribution margin from 300 units of BV is 300 x 90 = $27,000

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Analysis 2: If make BV, then total units of BV that the leased machine would be able to make is 150 / 1 is 150 units of BV. Again the relevant revenues from leasing the asset would be the contribution margin from selling the additional BV units (150 units) which is now possible with the leased machine. This 150 units of BV would earn a total contribution margin of 150 x 90 = $13,500

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Conclusion: break-even lease payment is 27,000 (i.e., the higher of the two)

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Page 3 of 4

The following approach to answer 4 c is also acceptable. 

Contribution margin per machine hour for new machine o SC: 120/0.3 = 400 >> same as old machine o BV: 90/1 = 90 >> lower than old machine o

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Therefore, use new machine to make SC and old machine to make BV.

New machine makes SC: total units SC that the leased machine would be able to make = 150/0.3 hours = 500 units of SC. This 500 units of SC made by the leased machine would create 150 hours of spare capacity in the company’s machine. This would allow 150 hours / 0.5 = 300 units of BV to be made by the existing machine for which there is existing demand for. The relevant revenues from leasing the machine would be the contribution margin from selling the additional BV units since the demand for SC is totally fulfilled under both alternatives. The additional contribution margin from 300 units of BV is 300 x 90 = $27,000 Therefore the breakeven lease payment is 27,000

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