91Ó°ÊÓ

The Thomas Corporation sells \(300,000 \mathrm{V} 262\) valves to the automobile and truck industry. Thomas has a capacity of 110,000 machine-hours and can produce 3 valves per machine-hour. V262's contribution margin per unit is \(\$ 8 .\) Thomas sells only 300,000 valves because 30,000 valves \((10 \%\) of the good valves) need to be reworked. It takes one machinehour to rework 3 valves, so 10,000 hours of capacity are used in the rework process. Thomas's rework costs are \(\$ 210,000 .\) Rework costs consist of the following: \- Direct materials and direct rework labor (variable costs): \(\$ 3\) per unit \- Direct materials and direct rework labor (variable costs): \(\$ 3\) per unit Thomas's process designers have developed a modification that would maintain the speed of the process and ensure \(100 \%\) quality and no rework. The new process would cost \(\$ 315,000\) per year. The following additional information is available: \- The demand for Thomas's V262 valves is 370,000 per year. \- The Jackson Corporation has asked Thomas to supply 22,000 T 971 valves (another product) if Thomas implements the new design. The contribution margin per \(\mathrm{T} 971\) valve is \(\$ 10 .\) Thomas can make two T971 valves per machine-hour with \(100 \%\) quality and no rework. 1\. Suppose Thomas's designers implement the new design. Should Thomas accept Jackson's order for 22,000 T971 valves? Show your calculations. 2\. Should Thomas implement the new design? Show your calculations. 3\. What nonfinancial and qualitative factors should Thomas consider in deciding whether to implement the new design?

Step by step solution

01

Calculate Current Valves Produced and Hours Used

Thomas currently sells 300,000 V262 valves. Since 10% are reworked, the number of good valves is already included in the 300,000. It takes 10,000 hours to rework these 30,000 valves (since 1 machine-hour reworks 3 valves). The hours used for production minus rework are\[\text{Machine-hours for production} = \frac{300,000}{3} = 100,000 \text{ hours}\]and additional 10,000 for rework totals 110,000 hours used (equal to capacity).

02

Calculate Current Profitability

To calculate profitability, consider the contribution margin and costs:- Contribution Margin for 300,000 V262 valves is:\[300,000 \times 8 = \\(2,400,000\]- Rework costs are \\)210,000.Thus, the current profit is:\[2,400,000 - 210,000 = \$2,190,000.\]

03

Analyze the New Design and Additional Orders

With the new design:- No rework is needed, releasing 10,000 machine hours.- Fulfillment of 370,000 V262 valve demand, using:\[\frac{370,000}{3} = 123,333.33 \text{ hours (approximately 123,334 hours)}\]- This exceeds capacity without rework (110,000 hours), meaning Thomas can't produce all V262 and additional T971 with the current capacity.

04

Evaluate Jackson's Order for T971 Valves

Jackson's order allows production of 22,000 T971 valves. Contribution is:\[22,000 \times 10 = \$220,000.\]Given the new design, producing these takes:\[\frac{22,000}{2} = 11,000 \text{ hours.}\]Thomas lacks enough capacity (110,000 total hours) to produce 370,000 V262 valves and 22,000 T971 valves.

05

Consideration of Implementing the New Design

The annual cost of the new design is \\(315,000. The ideal production of 370,000 V262 valves at a contribution margin of \\)8 is \\(2,960,000 without rework costs:\[2,960,000 - 315,000 = \\)2,645,000.\]Comparing this to the current profit (\$2,190,000), implementation is beneficial if productivity increases offset hours used.

06

Financial Analysis Conclusion

While the new design appears initially beneficial from cost savings, it fails to free enough machine-hours within the existing capacity for Jackson's order. Excess demand on hours means only redesigning for existing products yields an outcome without additional T971 production.

07

Nonfinancial Considerations

Consider future product demands, machine upgrades to increase capacity, customer satisfaction from higher quality, potential loss of sales to competitors if capacity isn't increased, and employee impacts of process changes.

Unlock Step-by-Step Solutions & Ace Your Exams!

• Full Textbook Solutions

  Get detailed explanations and key concepts

• Unlimited Al creation

  Al flashcards, explanations, exams and more...

• Ads-free access

  To over 500 millions flashcards

• Money-back guarantee

  We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with 91Ó°ÊÓ!

Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Capacity Management

Capacity management involves ensuring that a company's production capabilities align with the demands for its products. Thomas Corporation has a production capacity of 110,000 machine-hours. Under current operations, they use this entire capacity to produce and rework V262 valves.

• Currently, 10,000 hours are used to rework defective valves.
• This results in fewer hours available for producing salable products, limiting the company's potential to meet increased demand.

If Thomas implements the new process design, these rework hours would be eliminated, freeing up more capacity. However, even without rework, Thomas's existing capacity would still be insufficient to fulfill both the demand for 370,000 V262 valves and any additional products like T971 valves from Jackson Corporation.
This means careful planning and possibly expanding capacity are needed to fully exploit market opportunities and maximize revenue.

Contribution Margin

The contribution margin is a key metric in evaluating product profitability. It tells how much revenue from each valve sold contributes to the overall profitability after variable costs.

• For Thomas, the contribution margin per V262 valve is $8.
• This means that for every valve sold, $8 contributes to covering fixed costs and profit.

When considering the option to implement a new process design, evaluating how the contribution margin will be affected is crucial. If the new process can ensure all valves produced are sold without the need for rework, the contribution margin increases due to reduced waste.
Additionally, if Thomas accepts Jackson's order for T971 valves, these have a higher contribution margin of $10 per valve, potentially increasing overall profitability if capacity permits.

Process Improvement

Process improvements aim to increase efficiency and product quality, reducing time and costs associated with production. The new design suggested for Thomas Corporation achieves this objective by eliminating rework.

• This would ensure 100% quality in valve production.
• Rework elimination allows for more effective use of machine hours, increasing actual production capacity.

Implementing the process improvement comes with a cost of $315,000 annually. However, this cost is potentially justified by the savings from reduced rework and improved output. Moreover, higher quality products can enhance customer satisfaction, reducing the risk of losing clients to competitors due to quality issues.
Overall, effective process improvement can lead to better resource utilization, cost savings, and increased customer trust, all vital for long-term business growth.

Rework Costs

Rework costs represent additional expenses incurred due to defective products requiring correction. For Thomas Corporation, these costs are significant at $210,000 annually due to 30,000 valves needing rework.

• Each valve reworked incurs direct variable costs of $3.
• This process uses 10,000 machine hours that could otherwise produce new products.

The goal of reducing or eliminating rework costs is central to Thomas’s consideration of process improvement. By eliminating these defects upfront through a new process, Thomas would not only save money on rework costs but also unlock more machine hours for production.
This can help in meeting additional demand effectively, making the business more competitive while improving the efficiency of its operations.