Chapter 7- Solved Problems

Problem 1
Cox Industries produces sporting goods. Cox posted the following yearly earnings and
expenses for 200X:

Earnings and Expenses (in millions)

Sales 22,327
COGS 17,596
Pre-tax Earnings 3,404
Selected Balance Sheet Items
Merchandise Inventory 3,722
Total Assets 13,754

Calculate:
a. Profit margin
b. Return of assets
c. The impact of a 7% reduction of COGS and merchandise inventory on Profit
margin
d. The impact of a 7% reduction of COGS and merchandise inventory on ROA
e. How much additional sales would Cox need to generate in order to achieve the
same impact as a 7% reduction in merchandise cost?

Answer Problem 1
a. Profit margin = 100% (Earnings/Sales)
PM = 100% (3404/22327) = 15.25%
b. ROA = 100% (Earnings/Assets)
ROA = 100% (3404/13754) = 24.75%
c. New Matrix
Earnings and Expenses OLD NEW
Sales 22,327 22,327
COGS 17,596 16,364
Pre-tax Earnings 3,404 4,636
Selected Balance Sheet
Items
Merchandise Inventory 3,722 3,462
Total Assets 13,754 13,494
Profit margin = 100% (Earnings/Sales)
PM = 100% (4636/22327) = 20.76%

d. Using the matrix from above

ROA = 100% (Earnings/Assets)
ROA = 100% (4636/13494) = 34.36%

e. (Pre-tax new – pre-tax old)/Profit margin = (4,636 – 3,404)/15.25% = 8,079

Problem 2
Cox has decided to assess the feasibility of outsourcing a portion of their in-house
production. A reputable supplier has bid $.72 per product on 400,000 products over a 3-
year period. Shipping will cost a fixed $.007 per unit. Additionally, we must consider the
cost of additional quality control at receiving, estimated at $1,667.67 per month and the
additional cost associated with ordering, estimated at $8,000 per year. Current
manufacturing costs for in-house production include one supervisor at $26,800 per year,
three part-time employees at $6,000 per year, direct materials at $.13, equipment
depreciation on a machine that will have no salvage value at the end of 3 years with a
current value of $13,200, and overhead allocated to the product at the rate of $260,000
per year. Using total costing, which option is best?

Answer Problem 2

Direct labor and benefits $ .045 = (3*6,000) / 1,200,000

Indirect labor and benefits $ .067 = 26,800/1,200,000
Direct materials $ .13
Equipment depreciation $ .011 = 13,200/1,200,000
Overhead $ .65 = (3*260,000)/1,200,000
TOTAL $ .903

The outsourcing option has the following costs associated with it:
Purchase price $ .72
Shipping and handling $ .007
Ordering cost $ .02 = (8,000*3)/1,200,000
Quality control $ .05 = (1,667.67*36)/1,200,000
TOTAL $ .797

Over the life of the product, outsourcing production will result in a $127,200 increase.
(.903-.797) * 1,200,000 = $127,200

Problem 3
Having selected outsourcing as a viable option, Cox now must choose between two
competing bids. Both Blackstone Production and Williams Widgets have made
competing offers at similar prices. The summary data for the two contract manufacturers
is given below:

Performance Dimension Blackstone Williams

Price $ .72 per unit $ .75
Quality 7% defective 2% defective
Dependability 95% on time 91% on time
Lead time 10 days 3 days

Based on a traditional five-point scale (5 being the highest), the following weights and
rankings were given to both organizations.
Performance Weight Blackstone Williams
Dimension
Price .2 5 4
Quality .4 3 4
Dependability .25 4 3
Lead time .15 2 4

Using the weighted point evaluation system, which contract manufacturer should Cox
award the business to?

Answer Problem 3

Blackstone Score = (.2*5) + (.4*3) + (.25*4) + (.15*2) = 3.5

Williams Score = (.2*4) + (.4*4) + (.25*3) + (.15*4) = 3.75

Award the business to Williams Widgets.