Solved: SCX is a 2 billion chemical company with a plastics

SCX is a $2 billion chemical company with a plastics plant located in Durango, Colorado. The
Durango plastics plant of SCX was started 30 years ago to produce a particular plastic film for
snack food packages. The Durango plant is a profit center that markets its product to film
producers. It is the only SCX facility that produces this plastic.

A few years ago, worldwide excess capacity for this plastic developed as a number of new
plants were opened and some food companies began shifting to a more environmentally safe
plastic that cannot be produced with the Durango plant technology.

Last year, with Durango's plant utilization down to 60 percent, senior management of SCX
began investigating alternative uses of the Durango plant. The Durango plant's current annual
operating statement appears in the accompanying table.

DURANGO PLANT

Income Statement, 2015

(Millions)

One alternative use of the Durango plant's excess capacity is a new high-strength plastic used
by the auto industry to reduce the weight of cars. Additional equipment required to produce the
automotive plastic at the Durango plant can be leased for $3 million per year. Automotive plastic
revenues are projected to be $28 million and variable costs are $11 million. Additional fixed
costs for marketing, distribution, and plant overhead attributable solely to auto plastics are
expected to be $4 million.

All of SCX's divisions are evaluated on a before-tax basis.

Required:

a. Evaluate the auto industry plastic proposal. Compare the three alternatives: (1) close
Durango, (2) produce only film plastic at Durango, and (3) produce both film and auto plastic at
Durango. Which of the three do you suggest accepting? (If Durango is closed, additional one-
time plant closing costs just offset the proceeds from selling the plant.)

b. Suppose the Durango plant begins manufacturing both film and auto plastic. Prepare a
performance report for the two divisions for the first year, assuming that the initial projections
are realized and the film division's 2016 revenue and expenses are the same as in 2015. Plant
administration ($17 million) and depreciation ($5 million) are common costs to both the film and
auto plastics divisions. For performance evaluation purposes, these costs are assigned to the

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 two divisions based on sales revenue. All costs incurred for the Auto Plastics division should be
charged to that division.

c. Does the performance report in part (b) accurately reflect the relative performance of the two
divisions? Why or why not?

d. In the year 2017, the Durango plant is able to negotiate a $1 million reduction in property
taxes. Property taxes are included in the "plant administration account." In addition, the Film
Division is able to add $3 million in additional revenues (with $2.1 of additional variable cost) by
selling film to European food packagers. Assuming that these are the only changes at the
Durango plant between 2016 and 2017, how does the Auto Plastics Division's performance
change between these two years? Allocate the common costs using the method described in
part (b).

e. Write a short memo evaluating the performance of the Auto Plastics Division in light of the
events in the year 2017 and describing how these events affect the reported performance of the
Auto Plastics Division?

SCX is a 2 billion chemical company with a plastics

ANSWER
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