Case 2-5 PROFITABILITY ISSUES AT CCC
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1 Case 2-5 PROFITABILITY ISSUES AT CALIFORNIA CAR COMPANY Case Objectives 1. Introduce students to pricing decisions 2. Demonstrate the use of cost accounting information to support pricing decisions 3. Assess profitability of products and firms using financial data Decision (Pricing): Does CCC need to adjust prices or reduce costs to remain competitive?
ASSESSING YEAR 2018 PRICES It is now early March 2018. Jena Butler, Vice President of Finance, Sally Swanson, Vice President of Production, and George Olson, Vice President of Marketing, are presently working together on a project involving a review of the company's selling prices for its sedan and compact vehicles, which are currently set at £21,000 and £17,000, respectively. Up to now, the company has relied heavily on its assessment of customers' willingness to buy electric vehicles and on legal and political constraints in setting its prices (see Reading2-5). The project team believes that it should re-examine its current prices in light of recent industry data that the team has just received (see Exhibit C2-5.1). Jena also has compiled recent cost and budget information provided by the company's accounting system (see Exhibits C2-5.2 andC2-5.3, Case2-4, and your individual solution to Case2-4). Exhibit C2-5.1 2017 Hybrid Vehicle Industry Percentage Income Statement Percent Sales 100% Cost of goods sold Direct materials 16% Direct labour 15% Manufacturing overhead 27% Total cost of goods sold 58% Gross margin 42% Selling and administrative expenses Selling expenses 10% Administrative expenses 19% 29% Income before tax 13% Income tax (30%) 4% Net income 9% Average industry sedan price £ 20,000 Average industry compact price £ 17.000 "Looking back, we've kept our prices constant at their current levels since 2016, and our budget for 2018 reflects those same prices," stated George. "I'm concerned that our prices are too high. If I'm right, we will miss both our 2018 sales volume targets and our profit targets. Our dealers tell me that they are losing sales to interested customers due to our prices. Can we be competitive in the long run by using our current prices? Let's reduce our profit on each car and cut the price of the sedan to £20,000 and the compact to £16,000. I wonder what our competitors are doing?" queried George.
2 "That's a good question," Sally responded. "When I look at our current prices in light of our estimated total manufacturing costs for 2018, those prices seem somewhat high. If our prices are too high, I'm worried about customers not buying our planned sales volume and the possibility of an inventory building up during 2018 if they don't. However, we don't want to reduce our projected net income. Both our shareholders and creditors are demanding that level of profitability. " "I think you've both identified significant issues," said Jena. "I am concerned about the impact of a price reduction on our margins. Let me work up an analysis of the markups implied in our 2018 budget plan and a comparison of those markups with the competition. Let's plan to reconvene next Monday and go over the figures." Exhibit C2-5.2 CCC Pricing and Cost Information Based on 2018 Estimates in Case 2-4 Sedan Compact Sales price £ 21,000 £17000 Direct materials cost £ 2,980 £3,360 Direct labour cost 3,780 2,275 Manufacturing overhead Variable £ 3,888 £ 2,340 Fixed 5,016 8,964 3,055 5,395 Total manufacturing cost £15,724 £ 11,030 Production volume (in units) 5100 1700 Requirements 1. Complete the costs in the table below. Assume that £2,000,000 of selling expenses and £1,000,000 of administrative expenses are variable. Fixed manufacturing costs are inserted in the table. Add the variable costs. Leave the shaded cells blank. One Sedan
One Compact
All Sedan All Compact CCC Total Variable manufacturing costs Fixed manufacturing costs £ 5.976
£ 3,055
£ 25,887,600 £ 5,193,500 £ 31,081,100 Total manufacturing costs Total Variable costs 2. In response to George's and Sally's concerns, determine the following: a. CCC 's estimated year 2018 markup percentages on estimated variable manufacturing cost per unit for each type of vehicle, Sedan and Compact. you need to calculate two separate markup percentages. b. CCC's estimated year 2018 markup percentage on estimate d total manufacturing cost per unit for each type of vehicle, sedan and compact. You need to calculate two separate markup percentages. c. CCC's total year 2018 corporate markup percentage on estimated total manufacturing costs reflected in its 2018 budgeted income statement in Exhibit C2-5.3. You need to calculate only one separate markup percentage for all of ccc. d. The industry average markup percentage in 2017 on total manufacturing costs use Exhibit C2-
5.1.
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