Classic Pen Company
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Classic Pen Company – Executive summary
Problem definition:
When introducing a new product mix, which includes an additional red and purples pen, the new products profitability rise but overall profitability fell; all four products failed to generate the expected return.
Analysis:
Introducing red and purple pens to the product line increases significantly the total overhead cost (exhibit 2):
Reduce the total units per run rate from 900 (blue and black) to 667 for all colors
Reduce the number of units produced per setup hour from 360 to 190
Administration rate reduced from 45,000 units per type to 25,000
Total over head per sales volume is significantly higher for red and purple pens with 92.4% and 249% respectively compare to a modest 26.4% and 25.3% for the blue and black pens respectively (exhibit 3).
Total return on sale average is down from 22% for only the blue and black pens to 13.5% for all colors (exhibit 3).
Return per sales is negative for red and purple pens with -44% and -200% respectively (exhibit 3)
Recommendations:
Due to its negative return it is recommended to stop production of red and purple pens and focus on production of blue and black pens only.
Production of red and purple (or alternative color) should resume only after:
Classic Pen Company shall perform a break even analysis which will ravel the required sales volume for profitability.
Explore the option of increasing volume for red and purple in order to cash in from production economies of scale.
Increase selling price for red and purple in order to compensate for the large overhead associated with their production.
Exhibits Appendix
Exhibit 1 – OverHead Cost Summary
OverHead
Cost
Total
Indirect Labour
$ 20,000
fringe Cost @40% of Indirect labour
$ 8,000
$ 28,000
Computer Systems
$ 10,000
$ 10,000
Machinery
$ 8,000
Maintenance
$ 4,000
Energy
$ 2,000
$ 14,000
Total
52,000
Exhibit 2 – OverHead Cost Allocation – ABC Approach
Black
Purple
Total
Production volume
50,000
40,000
9,000
1,000
100,000
# of Production runs
50
50