Evaluating Investment Decisions

Question 1
Design Manufacturing produces and sells a single product.
Original data concerning this product appear below:

Per Unit Percent of Sales
Selling price R150 100%
Variable expenses 45 30%
Contribution margin R105 70%

Fixed expenses are R500 000 per month.

Answer the following questions
1.1. The company is currently selling 6 100 units per month. The marketing manager believes that a R15 000 increase in the monthly advertising budget would result in a 175 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change?

1.2. Refer to the original data when answering this question.
Management is considering using a new component that would increase the unit variable cost by R6. Since the new component would increase the features of the company's product, the marketing manager predicts that monthly sales would increase by 350 units. What should be the overall effect on the company's monthly net operating income if this is implemented and achieved?

1.3. Refer to the original data when answering this question.
The marketing manager would like to cut the selling price by R6 and increase the advertising budget by R30 000,000 per month. The marketing manager predicts that these two changes would increase monthly sales by 550 units. What should be the overall effect on the company's monthly net operating income if this is implemented and achieved?

1.4. Refer to the original data when answering this question.
The marketing manager would like to introduce sales commissions as an incentive for the sales staff. The marketing manager has proposed a commission of R11 per unit. In exchange, the sales staff would accept a decrease in their salaries of R68 000 per month. (This is for the entire sales staff.) The marketing manager predicts that this sales incentive would increase monthly sales by 120 units. What should be the overall effect on the company's monthly net operating income if this is implemented and achieved?

Question 2
Hot Products CC uses part FZ1 in one of its products. The company's accounting division reports the following costs of producing the 8,000 units of the part that are needed every year.

Per Unit
Direct materials R8.00
Direct labor R4.30
Variable overhead R8.50
Supervisor's salary R3.30
Depreciation of special equipment R2.60
Allocated general overhead R1.25

An outside supplier has offered to make the part and sell it to the company for R28.00 each. If this offer is accepted, the supervisor's salary and all variable costs, including direct labor, can be avoided. The special equipment used to make the part was purchased many years ago and has no salvage value or other use. The allocated general overhead represents fixed costs of the entire company. If the outside supplier's offer were accepted, only R3 000 of these allocated general overhead costs would be avoided. In addition, the space used to produce part FZ1 could be used to make more of one of the company's other products, generating an additional segment margin of
R16 500 per year for that product.

Required:

2.1. Prepare a report that shows the effect on the company's total net operating income of buying
part FZ1 from the supplier rather than continuing to make it inside the company.
2.2. Which alternative should the company choose?

Question 3
Manning Rangers Football Club has a small bus that is in poor mechanical condition. The bus can be either overhauled now or replaced with a new bus. The following data have been gathered concerning these two alternatives:

Present Bus New Bus
Purchase cost new R320 000 R400 000
Remaining net book value R180 000 ?
Major repair needed now R90 000 ?
Annual cash operating costs R120 000 R80 000
Salvage value now R100 000 ?
Trade-in value in seven years R20 000 R50 000

Manning Rangers could continue to use the present bus for the next seven years. Whether the present bus is used or a new bus is purchased, the bus would be traded in for another bus at the end of seven years. The club uses a discount rate of 12% and the total cost approach to net present value analysis in evaluating its investment decisions.

1. If the new bus is purchased, what is the present value of the annual cash operating costs associated with this alternative?
2. If the present bus is repaired, what is the present value of the annual cash operating costs associated with this alternative?
3. If the present bus is repaired, calculate the present value of the salvage received on sale of the bus seven years from now.