Merton Truck Company

1
Top Management of Merton Truck Company is planning to revisit the
current product mix of the company involving two models of trucks M101
and M102 as the President of the company feels that M101 truck is not
contributing to companys pro!t" #he also feels that purchasing engines
from an outside supplier may be a good option as it eases the capacity
problem in the engine assembly department"
Manufacturing of the trucks are carried out in a three stage process
involving engine assembly$ metal stamping and model assembly" The !rst
two activities are common for both the models while model assemblies
are carried out in two separate departments$ one for each model" %ata on
machine hour re&uirements for each truck model in each department and
monthly machine hour availability in the departments are given in Table 1
below" 'ssume there are no demand constraints for sale of trucks"
Table 1 Machine hour requirements and availability
Department Machine hours required
per truck
Total machine
hours available
per month Model 101 Model 102
(ngine 'ssembly 1"0 2"0 )000
Metal #tamping 2"0 2"0 *000
Model 101
assembly
2"0 +++ ,000
Model 102
assembly
+++ -"0 ),00
%uring the past six months the company had produced 1000 M101 and
1,00 M102 trucks per month" 't this level of production Model 102
assembly and engine assembly were working at full capacity while the
other two departments of metal stamping and M101 assembly were
operating at only .-"-/ and )0/ of capacity respectively" Table 2 gives
standard cost at this level of production while Table - gives details on
overhead costs
Table 2 Standard Product Costs
Model
101
Model
102
Direct
materials
$24!!! $2!!!!
Direct "abor
(ngine
'ssembly
1$200 2$)00
Metal
#tamping
.00 *00
0inal
'ssembly
2$000 $ 4!!! 1$,00 $4#!!
$verhead 1see
Table -2
(ngine
'ssembly
2$,2, )$.,0
1
Metal
#tamping
-$).0 -$0.0
0inal
'ssembly
*$200 $
122!#
-$,00 $114%!
$4!2!# $%#&%!
Table % $verhead 'ud(et durin( last si) months
Department Total
Overhead per
month
($ Millions)
Fixed
Overhead per
month
($ Millions)
*ariable
$verhead+unit
Model
101
Model
102
(ngine 'ssembly 3". 1"4 2$100 )$000
Metal #tamping ."1 2"4 2$)00 2$000
Model 101
assembly
*"2 2"4 -$,00 ++
Model 102
assembly
,"2, 1", ++ 2$,00
2&,%# -,. $-!!! $-#!!
The sales price of M101 truck is 5-3$000 while for M102$ it is 5-.$000"
#ales manager feels that 1from Table 22$ truck M101 is making a loss of
5120, for every truck sold and recommends discontinuation of the model"
6ut the cost accountant feels that the problem is in the accounting
system followed" 78e are trying to absorb the entire !xed overhead of
M101 assembly over only 1000 trucks" 8e would be better o9 increasing
production of M101 trucks$ cutting back if necessary on Model 102
production: he opined" Production manager on the other hand has a
di9erent view" 78e can relieve the capacity problem in engine assembly
by purchasing M101 or M102 engines from an outside supplier" 8e will
furnish necessary materials and engine components and reimburse the
supplier for labor and overhead" This way we can increase M101
production without cutting back M102 production:
8hat should they do;
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Questions for Discussion
1" a" 0ind the best product mix for Merton
b" 8hat would be the best product mix if engine assembly
capacity were raised by one unit 1i""e from )000 to )001
machine+hours2 8hat is the extra unit of capacity
worth;
c" 'ssume that second additional unit of engine assembly
capacity is worth as the !rst" <erify that is capacity were
increased to )$100 machine+hours$ then the increase in
contribution would be 100 times of that in part 1b2
d" =ow many units of engine assembly can be added before
there is a change in the value of an additional unit of
capacity;
2. #hould Merton pursue the suggestion of production manager
to renting engine assembly capacity from an outside
supplier; >f yes$ what is the maximum rent it should be
willing to pay for a machine+hour of engine assembly
capacity; 8hat is the maximum number of machine hours it
should rent;
-" Merton is considering introduction of a new truck M10- each
unit of which would give a contribution of 5 2000" The total
engine assembly would be su9icient to produce ,000 units of
m10- per month and total metal stamping capacity would be
su9icient to produce )000 units of Model M10-" The new
truck would be assemble in M101 assembly department$ each
model M102 truck re&uiring only half as much time as M101
truck
a" #hould Merton produce M10- trucks;
b" =ow high would be the contribution on each M10-
truck has to be before it became worthwhile t produce
the new model;
)" (ngines can be assembled on overtime in the engine
assembly department" #uppose$ production e9iciencies do
not change and 2$000 machine hours of over time capacity is
available in engine assembly department" %irect labor costs
are higher by ,0/ for overtime production" 8hile variable
overhead would remain the same$ monthly !xed overhead in
the engine assembly department would increase by 50"4,
million" #hould Merton assemble engines on overtime;
," ' market study revealed that M101 trucks have a better
7brand image: in the market and discontinuing same may not
be good for the company in the long run" 8hat should be the
optimal product mix that maximi?es the monthly contribution$
if it is necessary to ensure that number of M101 trucks
produced per month is at least three times that of M102
trucks produced$ to enhance the brand image;