Question

FUDICI! nition At the end of 2002, Graylevy Machining, hired Mary Lou Morris to manage one of its troubled divisions. Mary Lou had the reputation of turning around businesses that were having difficulty. In 2003, the division had sales of $300 million, a unit- level variable cost ratio of 0.8, and total fixed costs of $72 million. The division produced only one product, and all sales were to external customers. Seeking to solve the division's problems, Mary Lou asked for a report on quality costs for 2003 and received the following report: Fixed Variable (unit-level) Prevention $ 2,400,000 Appraisal ภปาก ๆ 3,600,000 $12,000,000 Internal failure 6,000,000 24,000,000 External failure 12,000,000 60,000,000 $24,000,000 $96,000,000 ประหลาดใจ Mary Lou was astounded at the level of expenditure on quality costs. Although she had heard of companies with quality costs that had reached as high as 60 percent of sales, she had never personally seen any greater than 20 to 30 percent of sales. This division's level of 40 percent was clearly excessive. She immediately imple- mented a program to improve conformance quality. By the end of 2004, the following quality costs were reported: Total

Please help

Answer 1

1. Calculate the break-even point in revenues for 2003. How much was the division losing?
Break even Point = Fixed Cost/ Contribution Margin Ratio
Break even Point = $72,000,000/ (1-80%)	$ 360,000,000.00
Loss = 0.2 × ($360,000,000 – $300,000,000) =	$ (12,000,000.00)
2. Calculate the break-even point in 2004. Explain the change.
New fixed costs = $72,000,000 + ($42,000,000 - $24,000,000)	$   90,000,000.00
New variable cost ratio:
Old variable costs = $300,000,000 x 80%	$ 240,000,000.00
New variable costs = $240,000,000 – (96,000,000 - $66,000,000)	$ 210,000,000.00
New variable cost ratio = $210,000,000/$300,000,000	70.00%
Break even Point = Fixed Cost/ Contribution Margin Ratio
Break even Point = $90,000,000/ (1-70%)	$ 300,000,000.00
Mary Lou chose to spend more fixed costs on appraisal and prevention activities. This had the effect of reducing variable quality costs (failure costs) and lowering the variable cost ratio from 80%  to 70% . Although the change in one year was not dramatic, it did produce a break-even outcome for the division.
3. Calculate the break-even point in 2008, assuming that revenues and other costs have remained the same. Is it possible to reduce quality costs as dramatically as portrayed?
New fixed costs = $72,000,000 - ( $24,000,000 - $4,800,000)	$   52,800,000.00
New variable cost ratio:
Old variable costs = $300,000,000 x 80%	$ 240,000,000.00
New variable costs = $240,000,000 – (96,000,000 - $1,200,000)	$ 145,200,000.00
New variable cost ratio = $145,200,000/$300,000,000	48.40%
Break even Point = Fixed Cost/ Contribution Margin Ratio
Break even Point = $52,800,000/ (1-48.40%)	$ 102,325,581.40
Yes, based on the experiences of numerous companies, quality costs can be reduced dramatically as quality improves. Reducing costs to 2.5 % of sales with 80% of total quality costs belonging to the control categories has been done. Quality improvement offers significant opportunities to improve profitability.
4.Assume that from 2003 to 2008, the division was forced to cut selling prices so that total revenues dropped to $180 million. Calculate the income (loss) that would be reported under a 2003 cost structure. Now, calculate the income (loss that would be reported under the 2008 quality cost structure (assuming all other costs remain unchanged). Discuss the strategic significance of quality cost man agement.
2003 cost structure:
Loss = 0.2 × ($360,000,000 – $3600,000,000) =	$ (36,000,000.00)
2008 cost structure:
Profit = (1 - 48.40%) x ($180,000,000 – $102,325,581)	$   40,080,000.00
By improving quality, quality costs were reduced so that prices could be reduced in response to competitive forces—and still maintain profitability. Otherwise, the division might not have survived. Strategic cost analysis is an effort to use cost information to help companies gain a sustainable competitive advantage. Quality costing certainly offers this potential use. Managing quality costs is critical in today’s competitive environment.