Saskatoun Shoes Inc. is a large footwear manufacturer located in Saskatoon, Sask

Question

Saskatoun Shoes Inc. is a large footwear manufacturer located in Saskatoon, Saskatchewan. It sells its products to wholesalers across Canada and internationally. Currently, the production process has a scrap rate of 16% and a return rate of 2%. Scrap costs are related to wasted material and are usually $14 per unit. Warranty costs average $40 per unit returned. The company is looking to invest in new equipment to improve its production processes and the quality of their shoes. It has the following three options to choose from. Your role is to help the company make the right choice.

Option 1: Invest $500,000 in new equipment. The new process will require an additional cost of $1.5 raw material per unit produced. However, it will reduce scrap return 40% from current levels.

Option 2: Invest $175,000 in new equipment. The new process will require an additional cost of $3 raw material per unit produced. However, it will reduce scrap return 94% from current levels.

Option 3: Invest $ 2.2 million in new equipment. The new process will require no additional cost of raw material per unit produced. However, it will reduce scrap return 50% from current levels.

Q Which option would you recommend if the current production level is 1.5 million units?

Explanation / Answer

Total units Scrap % Scrap units Scrap Amount ($14 per unit) Return % Return units Return Amount ($40 per unit) Total cost of Scrap return The current cost of Scrap return 1500000 16% 240000 3360000 2% 30000 1200000 4560000 Total costs 4560000 Option I Cost of scrap return 1500000 9.600% 144000 2016000 1.2% 18000 720000 2736000 Add : Material costs 2250000 Add : Equipment costs 500000 Total costs 5486000 Option II Cost of scrap return 1500000 0.960% 14400 201600 0.120% 1800 72000 273600 Add : Material costs 4500000 Add : Equipment costs 175000 Total costs 4948600 Option III Cost of scrap return 1500000 8.000% 120000 1680000 1.000% 15000 600000 2280000 Add : Material costs 0 Add : Equipment costs 2200000 Total costs 4480000 We advise the company to go for none of the option and stay with current production process as it has lowest costs of scrap return. The other three option given for evaluation are costlier compared to the current costs of scrap return.

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