Please read the following Scenario: Elisa McRay was recently hired as cost analy

Question

Please read the following Scenario:

Elisa McRay was recently hired as cost analyst by Medlab Medical Supplies Inc. One of Elisa's first assignments was to perform a Net Present Value analysis for a new warehouse. Elisa performed the analysis and calculated a Present Value Index of 0.75 the plant manager, Mark, is very intent in purchasing the warehouse because he believes that more storage space is needed. Mark asks Elisa into his office and the following conversation takes place:

Mark: Elisa, you are new here aren't you?

Elisa: Yes, sir.

Mark: Well, Elisa, let me tell you something. I'm not at all pleased with the capital investment analysis that you performed in these new warehouse. I need that warehouse for my production. If I don't get it, where are am I going to place our output?

Elisa: Hopefully with the customer, sir.

Mark: Now don't get smart with me.

Elisa: No, really, I was being serious. My analysis does not support constructing a new warehouse. The numbers don't lie, the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse does not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse.

Mark: Listen, you need to understand something. The headquarters people will not allow me to build the warehouse if the numbers don't add up. You know as well as I that many assumptions go into your Net Present Value Analysis. Why don't you relax some of your assumptions so that the financial savings will offset the cost?

Elisa: I'm willing to discus my assumptions with you. Maybe I overlooked something.

Mark: Good. Here is what I want you to do. I see in your analysis that you don't project greater sales as a result of the warehouse. It seems to me, if we can store more goods, then we will be able to manufacture more goods, which will mean we will have more to sell. Thus, logically a larger warehouse translate into more sales. If you incorporate this into your analysis, I think you will see that the numbers will workout. Why don't you work it through and come back with a new analysis. I am really counting on you on this one. Let's get off to a good start together and see if we can get this project accepted.

Please make sure that within your text you mention in detail:

1. What is your advise to Elisa? Why? (Please elaborate)

2. Is Mark correct on his assumption that a large warehouse will bring more sales? Why or Why not?

3. What will happen for each accounting period when production is increased but stored not sold? Describe the effect in the balance sheet and the income statement for the excess production period and the sales period. Hint, the accounts you want to look at are: Inventory, Cost of Goods Sold, Depreciation Expense.

Explanation / Answer

First of all lets take out some points for the expenses.

1. Elisa's assumption - analysis does not support constructing a new warehouse. The numbers don't lie, the warehouse does not meet our investment return targets. In fact, it seems to me that purchasing a warehouse does not add much value to the business. We need to be producing product to satisfy customer orders, not to fill a warehouse.

2.Mark's requirement -  It seems to me, if we can store more goods, then we will be able to manufacture more goods, which will mean we will have more to sell. Thus, logically a larger warehouse translate into more sales. If you incorporate this into your analysis, I think you will see that the numbers will workout.

1. What is your advise to Elisa? Why? (Please elaborate)

while analysing the requirement of a warehouse, Elisa should understand what are business needs as well customer needs with regards to the product. It would be a waste if we come to apoint without analysing such important perspectives. Along with it before doing the analysis she should understand what Mark has to say and whether the same is valid or not. And how that projection is going to affect the returns. How there wil be a value addition if we put our investment in warehouse and how the same is going to increase the profits. Elisa should do the analysis of the project in such a way that NPV is positive and all such factors related to the same is counted on.

2. Is Mark correct on his assumption that a large warehouse will bring more sales? Why or Why not?

The sales of the product totally depends upon the customer needs and demands. How the same is communicated in the market, If we havent done the market analysis. Mark assumption on large wrehouse will bring more sales is little impractical as warehouses will remain filled with the stock and new production will increases the store.
This is how inventory cost will be affected because we are only increasing our storage space and cost of the goods and there is no increase in the sales capacity of the goods.

3. What will happen for each accounting period when production is increased but stored not sold?

When Goods are stored ut not sold then -

Inventory - Wil increase, cost of inventory will increase
Cost of good sold - Expenses in manufacturing will increase,cost of expenses will increase, ad so the cost of sales will increase because only number of goods produced is increasing not sales

Depreciation - We are charging depreciation each year, as the depreciation will be increasing the expense side and there will be no income to waive this, this will automatically hit the profits of the company.

Balance sheet will be affected by the excess production period aswe will showcase the number of goods produced increased and not the number of goods sold so there is a direct effect on profits. In balance sheet, under current asset we will showcase the inventory is increased, but there is no increase in the cash side. so it wil affect the liquidity of the company.

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