Target prices, target costs, value engineering, cost incurrence, locked-in
costs, activity-based costing. Cutler Electronics makes an MP3 player, CE100,
which has 80 components. Cutler sells 7,000 units each month for \(\$ 70\) each.
The costs of manufacturing \(\mathrm{CE} 100\) are \(\$ 45\) per unit, or \(\$
315,000\) per month. Monthly manufacturing costs are as follows.
Cutler's management identifies the activity cost pools, the cost driver for
each activity, and the cost per unit of the cost driver for each overhead cost
pool as follows:
$$\begin{array}{lccc}
\begin{array}{l}
\text { Manufacturing } \\
\text { Activity }
\end{array} & \text { Description of Activity } & \text { cost Driver } &
\begin{array}{c}
\text { cost per Unit } \\
\text { of cost Driver }
\end{array} \\
\hline \text { 1. Machining costs } & \text { Machining components } & \text {
Machine-hour } & \text { \$4.50 per machine-hour } \\
& \text { capacity } & & \text { \$2 per testing-hour } \\
\text { 2. Testing costs } & \text { Testing components and final } & \text {
Testing-hours } & \text { (inder } \\
& \text { product (Each unit of CE100 } & & \\
\text { 3. Rework costs } & \text { Correcting and fixing errors } & \text {
Units of CE100 } & \text { \$20 per unit } \\
& \text { is tested individually.) } & \text { reworked } & \\
\text { 4. Ordering costs } & \text { Ordering of components } & \text {
Number of orders } & \text { \$21 per order } \\
\text { 5. Engineering costs } & \text { Designing and managing of } & \text {
Engineering-hour } & \text { \$35 per engineering-hour } \\
& \text { products and processes } & \text { capacity } &
\end{array}$$
Cutler's management views direct material costs and direct manufacturing labor
costs as variable with respect to the units of CE100 manufactured. Over a
long-run horizon, each of the overhead costs described in the preceding table
varies, as described, with the chosen cost drivers. The following additional
information describes the existing design:
a. Testing time per unit is 2.5 hours.
b. \(10 \%\) of the CE100s manufactured are reworked.
c. Cutler places two orders with each component supplier each month. Each
component is supplied by a different supplier.
It currently takes one hour to manufacture each unit of CE100.
In response to competitive pressures, Cutler must reduce its price to \(\$ 62\)
per unit and its costs by \(\$ 8\) per unit. No additional sales are anticipated
at this lower price. However, Cutler stands to lose significant sales if it
does not reduce its price. Manufacturing has been asked to reduce its costs by
\(\$ 6\) per unit. Improvements in manufacturing efficiency are expected to
yield a net savings of \(\$ 1.50\) per MP3 player, but that is not enough. The
chief engineer has proposed a new modular design that reduces the number of
components to 50 and also simplifies testing. The newly designed MP3 player,
called "New CE100" will replace CE100. The expected effects of the new design
are as follows:
a. Direct material cost for the New CE100 is expected to be lower by \(\$ 2.20\)
per unit.
b. Direct manufacturing labor cost for the New CE100 is expected to be lower
by \(\$ 0.50\) per unit.
c. Machining time required to manufacture the New CE100 is expected to be 20\%
less, but machine-hour capacity will not be reduced.
time required for testing the New CE100 is expected to be lower by \(20 \%\).
e. Rework is expected to decline to \(4 \%\) of New CE100s manufactured.
f. Engineering-hours capacity will remain the same.
Assume that the cost per unit of each cost driver for CE100 continues to apply
to New CE100.
1\. Calculate Cutler's manufacturing cost per unit of New CE100.
2\. Will the new design achieve the per-unit cost-reduction targets that have
been set for the manufacturing costs of New CE100? Show your calculations.
3\. The problem describes two strategies to reduce costs: (a) improving
manufacturing efficiency and (b) modifying product design. Which strategy has
more impact on Cutler's costs? Why? Explain briefly.
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