Jensen PVC, Inc., produces polyvinyl chloride (PVC) irrigation pipes. In 2017, t
ID: 2587003 • Letter: J
Question
Jensen PVC, Inc., produces polyvinyl chloride (PVC) irrigation pipes. In 2017, the cost of producing a foot of pipe was $0.30, and the selling price was $0.39 per foot. In 2018, production costs increased to $0.40 per foot, although the selling price remained at $0.39.
2017 2018
Selling price $0.39 $0.39
Production cost 0.30 0.40
The increase in cost was obvious. Material and labor had remained fairly constant per foot of pipe, but overhead costs, which were $0.15 per foot in 2017, had increased to $0.25 in 2018. The problem was that most overhead costs were fixed, but output had decreased due to weak crop prices and a corresponding decrease in spending on irrigation projects. Bob Elger, CFO of Jensen, reviewed the data generated by the company’s process costing system. In 2017, overhead costs in all of the company’s departments (mixing, extrusion, cutting, and packing) were $1,500,000, and pipe production was 10,000,000 feet. In 2018, overhead costs were still approximately $1,500,000, but pipe production decreased to 6,000,000 feet. At a recent meeting of the senior management team, Bob noted: “The problem is that we’re not making use of capacity. We could easily produce 15,000,000 feet of pipe given our state-of the art equipment, but we’re operating at less than 50% of capacity.”
Required
Bob estimates that to sell 15,000,000 feet of pipe in the current market, the company would have to lower its price to $0.35 per foot, which is even lower than its current cost per foot of $0.40. Would decreasing the price be a good decision?
Calculate expected profit for the two options: Existing price Lower Price Feet sold: 6,000,000 15,000,000 Price/ft Revenue Labor & Material Overhead Profit Incremental profit (change): Would decreasing the price to $0.35 be a good decision? Yes/No and explain why.Explanation / Answer
Expected Profit for 2 Options: Existing Price Lower Price Feet Sold - A 6,000,000 15,000,000 Price / Feet - B $0.39 $0.35 Revenue - C (A*B) $2,340,000 $5,250,000 Labour and Material - D $900,000 $2,250,000 (0.30 - 0.15) Fixed Overheads - E $1,500,000 $1,500,000 Total Costs - F (D+E) $2,400,000 $3,750,000 Profit - G (C-F) ($60,000) $1,500,000 Incremental Profit Change $1,560,000 Would decreasing the price to $0.35 is a good decision? Yes / No. Explain Why? Yes, decreasing the price to $0.35 / Feet is a good decision for the following reasons: 1. It enables the Company to utilise the capacity to fuller extent 2. It increases the profit of the Company by generating higher volumes 3. The price will be competitive in the market through which additional demand can be created
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