Solved: Oilers Company makes a computer desk that it

sells for

Oilers Company makes a computer desk that it sells for $30 under a contract to a large
computer retailer. The company operates one shift in its Ohio plant. The annual normal capacity
is 100,000 units. Oilers pays direct labor at $8.00 per hour. An employee can produce a desk in
2 hours. Each desk requires 8 board feet of hardboard costing $0.25 per board foot. Indirect
manufacturing costs (manufacturing overhead) at normal capacity of 100,000 units are
described by the following formula:
Total costs = Fixed costs + (Variable cost per unit x units manufactured
Total costs = $25,000 + ($0.30/unit x units manufactured)
Some years ago, Oilers installed a saw that now has a carrying (book) value of $20,000, which
is being depreciated at $2,000 a year. At the time of installation, the saw was expected to have
no salvage value at the end of its useful life because that value would equal its dismantling
costs. A sales agent from Whalers Company is encouraging Oilers Company to replace the saw
with a numerical saw. In addition to being able to perform precision cutting, the new saw also
will reduce by half the time to make a desk. Because the new saw is more powerful than the
present one, utility costs are expected to increase by $0.10 per unit. The new saw will cost
$100,000, including installation, testing, and transportation charges. Its estimated useful life is
10 years and will be depreciated using the straight-line (SL) method with $10,000 estimated
salvage value. Whalers Company agrees that, if Oilers buys the saw, Whalers will buy the old
one for $4,000 and charge Oilers no dismantling costs. The income tax rate is 40 percent. Oilers
management expects a 15 percent after-tax return on investment. The loss on the trade-in of
the current saw is allowable as an income-tax deduction.

Required
1. As a financial analyst for Oilers, you are charged with analyzing the purchase of the new saw.
In preparing a report for the president, you must determine the following for management’s
consideration:
a. The contribution margin per unit under current operating conditions.
b. The standard overhead rate (application rate) per unit under current operating conditions.
c. The formula for indirect manufacturing costs (manufacturing overhead), assuming the
purchase and installation of the new saw.
d. The new saw’s manufacturing overhead standard rate (application rate) per unit, based on a
normal capacity of 100,000 units.
e. The contribution margin per unit, assuming the sales price remains unchanged, if the new
saw is purchased and installed.
f. The net additional investment for the new saw, assuming that Oilers decides to purchase and
install it.
g. The expected net additional cash flow per year if the new saw is purchased and installed.
Assume that the company sells all that it produces.
2. The firm will be able to reduce approximately half of the hourly production workers currently
on its payroll if the new saw is purchased. The plant has been in its current location for more
than 50 years. Over 40 percent of the households in this small southeast Ohio town have at

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 least one member who works for the firm. Should the firm purchase the state-of-the-art
equipment? Why or why not?
(IMA Adapted)

ANSWER
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