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Question

Please see part 3:  https://www.chegg.com/homework-help/questions-and-answers/please-see-part-2-https-wwwcheggcom-homework-help-questions-answers-please-see-part-2-http-q25067742

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QUESTIONS

Part 1. In Exhibit 2, Blanchard currently estimates the setup cost per bottle run to be: S = (blending setup cost) + (size changeover cost) + (label changeover cost) + (order processing cost). To your information, this formula over-estimates the true cost per bottle run by including unnecessary cost items in the calculation. Please discuss your recommendations for correcting this calculation and explain your reasoning.

Continue. The inventory holding cost per unit, per year is H = C x K, where C is the cost of producing one unit of product and K is carrying cost percentage. However, the estimation of the value of both C and K are inaccurate due to misconception in the original rationale behind the current formula. Let’s correct the calculation of C and K.

Part 2. The company currently calculates the value of C using the following formula in Exhibit 2: C = (materials cost) + (bottling labor) + (fixed overhead allocation) + (variable overhead) + (customs duty) + (federal distilled spirits tax) + (federal rectification tax). The detailed explanation to each cost category therein is also provided in Exhibit 2. To your information, some cost items in the calculation should not be accounted towards the unit cost of production. Please discuss your recommendations for correcting this calculation and explain your reasoning.

Part 3. The current calculation of the carrying cost percentage K includes the cost of capital (in percentage) for financing the production and inventory of the five alcoholic beverages. The company believes that the cost of capital arises from the interest rate of capital (i.e., bank credit), which is 9%. To your information, the company fails to recognize the true cost of the capital given the financial condition and alternative investment opportunity of the company. Please discuss your thoughts about what should be the true cost of capital (in %) and explain why.

Explanation / Answer

Part 1:

The set-up cost per bottle run means the cost incurred in preparation of bottling runs, performing the bottling runs change overs, and administrative costs incurred for bottling runs. While Blending set-up costs, size changeover costs and order processing costs account for this, Label Changeover cost is the account of opportunity cost. It is the cost when the equipment is shut down and hence the labour is idle. The actual amount incurred already includes the idle time, so there is no extra cost incurred for this particular component in set-up cost. Hence, Labor Changeover Cost is an unnecessary item cost line.

Moreso, order processing cost is partly influencing bottling run cost and hence, set-up cost. It is a fixed overhead which includes cost of processing the customs duty forms, federal tax forms, state tax forms, and other paperwork which support not just bottling operations but cost of production as well which is unit cost (C). hence, only part of order processing cost should be considered in set-up cost

Part 2:

Federal distilled spirits tax = IRS tax on all spirits sold in the United States and varies with the alcoholic content of the beverage

Since, this tax is on items sold, this is not incurred until sale of the finished product. hence, this should not be accounted for in EOQ formula.

Part 3:

The company does not consider opportunity cost of investing equity.

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