New Product Development

New Product Development
Water Play Inc. ? Shark Scout Explorer
Managerial Accounting
Eleventh Edition
Garrison and Noreen

The company's engineers have just designed an underwater recreational vehicle combining scuba diving and jet skiing. It will allow individuals to explore underwater areas previously accessible only with sophisticated scuba diving gear and vast knowledge and experience of how to dive safely. However, because this vehicle allows the person to dive without suffering bends or other adverse diving conditions, it does not require a great deal of experience or skill. It is a fully programmed vehicle with a compression suit and chamber built in. It takes an inexperienced user about 5 hours to learn to operate and successfully use the vehicle for underwater exploration.
The company's design engineers have developed fully operational prototypes and an assembly diagram which has allowed the process engineers to develop a product specification sheet listing the assembly step process, parts used in assembly, and labor functions. This then allowed the accounting department to develop a standard "estimated" cost for these vehicles.
The mechanical engineers, process engineers, and manufacturing supervisors are in the process of designing the production flow in the plant located in Birmingham, Alabama. They have chosen to use the manufacturing cell design instead of a sequential or parallel flow. The facility has 200,000 square feet with most of that allocated for the manufacture of the vehicle and raw material component storage. A small portion of the facility will be used for finished goods storage, shipping and receiving, and other sales functions while the remainder will be used for general administrative functions such as accounting. About 5% is for the general administrative functions and 15% is for the sales and distribution functions. The remaining 80% is to be used for the manufacturing process. The land and building were purchased about 3 years ago under the expectation the company would grow and create new products that would need to be produced. The total cost of the purchase of land and building was $60 million. It is estimated that land constitutes about 20% of the cost of the purchase and the other 80% is the building's value. We are in the process of completing $24 million in renovations and modifications to the building. It will cost about $120 million for the manufacturing equipment purchases in order to begin manufacturing. Another $20 million will be incurred to acquire office equipment and furniture 70% of which will be allocated as a general administrative cost and 30% allocated to selling expenses. The company's management has made the decision to carry 10% of the first quarter's purchases needs in raw material inventory. These materials will be acquired before manufacturing operations actually begin. The product will probably be salable for 8 years and at the end of that time, the equipment is expected to be worthless since it is special purpose equipment and retooling would not be an option. The inventory will be completely eliminated and all other assets will be liquidated and any outstanding debts retired. Since we are not expecting to use the facility for other products, the land and building will be sold for approximately $8 million and $6 million respectively. The residual value for the office equipment and furniture is expected to be negligible and has been disregarded in calculating annual depreciation. The company uses straight-line depreciation for all its property, plant and equipment assets.
The company is forecasting monthly sales of 6,000 units and the selling price is set at $14,500 per vehicle. The demand and price should be consistent and not susceptible to fluctuating demand due to competition or changes in the economy. Since this vehicle is targeted at individuals who have large amounts of discretionary income, price is not expected to be elastic. Price fluctuations are not expected for the 8 years we expect to market this vehicle. After that time, larger competitors will develop and market significantly better and less expensive vehicles causing our line to become obsolete. Management has targeted an eight year product life cycle. Therefore our Birmingham facilities will be shutdown at that time. Materials will be the most costly component of manufacturing cost. Since we will buy all the components already manufactured to our specification from our suppliers, we will be doing a final assembly and quality assurance function in our plant. We will have an incoming parts inspection program to assure quality and specification compliance by our suppliers.
The engineers and cost accountant have developed a Bill of Materials which identifies each part by number and name. It also identifies the quantity of parts per vehicle, unit cost and total cost of each component. From this document, it is estimated the standard cost for materials will be $4,468 per vehicle. The accountants have developed the standard labor cost and overhead budget/cost for the first year as well. The standard labor time for each function was measured by time and motion studies and was affected by the manufacturing cell production flow chosen by the engineers and production managers. Manufacturing cells will have teams of workers responsible for assembling one vehicle completely. The speed of completion of one team will not directly impact the efficiency of other cells. This system also allows workers to be multi-task skilled and able to perform several assembly functions. We still identify labor departments because the skill level required of some cell team members is higher or lower than others which justifies a different pay scale for certain functions within the cell. The labor time per vehicle is expected to be 65 hours at a cost of $1,503.50 per vehicle.
We are paying a 6% sales commission to our sales representatives which comes to $870 per unit. The annual advertising budget for year one is planned at $60,000,000. We will assess the need for this high level of funding in future years but feel this expenditure in year one is essential to promoting this new product and creating brand recognition in the target market group. We will also support our dealers who will carry our vehicles in their showrooms through two efforts. First we will split the cost of transporting vehicles to the vendor by sharing payment of the shipping charges for each delivered vehicle. Second, we will provide technical support staff to train individuals who purchase our vehicles to assure they understand its proper operation. These technicians will award a certificate of completion once the customers have completed a five hour course.

Required: (Use Word and/or Excel to work through these questions)

1. Using the attached cost schedules, identify the following information about the costs in the Bill of Materials, Labor Routing, Manufacturing Overhead and Selling & General Administrative documents as being Product or Period costs, Variable or Fixed Cost behaviors, Direct or Indirect costs of the vehicle production. The costs that are identified as "fixed" costs can either be discretionary or committed for the annual budget period. Discretionary costs are those which are fixed by management decision but which can be eliminated in the short term of the budget year without doing irreparable damage to the company's operations. Using the fixed costs listed in the Selling and General Administrative cost schedule, identify which would be discretionary over the annual budget period and which would be committed. Provide written justification for those you believe would be discretionary.

2. Once you have identified the costs as either variable or fixed, identify variable costs per unit for the annual production expected and fixed costs in total for the year. Once you have identified costs by behavior, prepare a contribution format Income Statement based upon the 72,000 projected sales units for the year. How many units must the company sell to breakeven? What sales volume in dollars is needed to breakeven? If we sell the 6,000 expected units per month, what will be our profit?

3. Using the contribution income statement, compute the operating leverage ratio and margin of safety. Explain what each of those figures shows. What do these figures disclose about the projected profitability of Water Play?

See attached files for full problem description.