Case- Primus Industries

Primus Industries is a small manufacturing company based in Hosur. Primus manufactures three
industrial products HV, MV and LV in its single plant. These were sold by the company’s sales force for
use in the processes of other manufacturers. For many years the company has been profitable and
operated at capacity. However in the last few years the prices on all the 3 products were reduced and
selling expenses increased to meet competition and keep the plant operating at capacity. For the first
time, the company suffered losses in the year ending 31 st March 2011. The results for the previous year
of the company are shown below.

Primus Industries- Income statement for the year ended 31st March 2011.

Product HV Product MV Product LV Total

  ( in Rs.) ( in Rs.) ( in Rs.) ( in Rs.)
Units sold 24000 30000 15000
2154000
Sales 8640000 6300000 6600000 0
1719300
COGS 6648000 5220000 5325000 0
Gross Margin 1992000 1080000 1275000 4347000
Selling and Administrative
expenses 1776000 1185000 1290000 4251000
PBIT 216000 -105000 -15000 96000
Less: Interest       106000
Profit before tax       -10000

The company’s CEO was concerned about the results and was convinced that he could not unilaterally
raise prices without suffering volume declines. He felt that product MV should be dropped immediately
as it would be impossible to lower expenses on this product. The CFO of the company suggested a more
careful study of the costs and prices on all three products to determine the possible effects on the
operating income of the company if the MV is dropped. Then the CFO gathered the following
information.

 All the products are manufactured with common equipment, facilities and labour.
 Fixed selling and administration expenses are allocated on sales value basis to all the three
products
 Selling prices and shipping expenses of each of the three products are as follows. Shipping
expense is the only variable selling and administration expense.

Shipping
Unit sales price expenses per unit
( in Rs.) ( in Rs.)
Product HV 360 20
 Product MV 210 8
Product LV 440 20

The unit manufacturing costs for the three products are as follows:

Product HV Product MV Product LV

( in Rs.) ( in Rs.) ( in Rs.)
Direct material 62 44 100
Direct Labor 80 40 120
Variable Manufacturing overhead 90 60 90
Fixed Manufacturing Overhead 45 30 45
Total 277 174 355
 The company is manufacturing at capacity and selling all the products it produces.
 The company currently allocates fixed manufacturing overhead on the basis of machine
hours

Questions

1. If the company had dropped the product MV on 1 st April 2010, what effect would that action
have had on the operating income of the previous year?
2. What is the Primus’s most profitable product?
3. Since the company is operating at capacity and machine hours cannot be increased, what is the
optimal product mix for the company? What will be the profit/loss for the current year at that
product mix, assuming costs and prices remain the same as in the previous year? The maximum
demand for the three products in the current year are as follows

HV 30000 units MV 45000 units LV 25000 units

4. Assume that labour resources cannot be increased for the current year and the company has
sufficient machine hours. If Labour is paid at the rate of Rs. 40 per hour, suggest a product mix
to maximize the operating income of the company. The maximum demand remains the same as
in the previous question.
5. Which product will be given preference in your production schedule if the raw material is the
Limiting factor of production?
6. An outside company has offered to sell all the three products at prices of Rs.310 for HV, Rs.195
for MV and Rs.380 for LV to Primus Industries. If the machine hours are limited as stated in Q.3
above, should the Primus Industries outsource the production of any of these products to the
outside company?