Case Analysis For Precision Worldwide, Inc. Considering the option of continuing production of steel rings or switching to plastic rings

by icyzin (student)

University Degree Business and Administrative studies

Case Analysis For Precision Worldwide, Inc

指导教师：扶清

小组成员：黄志鑫 09302050 高松 09304048 施昭 09303030

Solution

Considering the option of continuing production of steel rings or switching to plastic rings, incremental analysis demonstrates plastic rings will decrease cost while decrease increasing profit.

Table 1

*The company sells 690 rings per week. Since cost calculations are in hundreds, price ($1,350) is multiplied by 6.90 (690/100) to obtain revenue generated per week. Manufacturing cost is also multiplied by 6.90 to compute cost per week.

Incremental revenue between Plastic and Steel is zero. This results from the company charging the same price for both products. Incremental cost decreases by $5,714.93, likewise yielding an incremental profit of $5,714.93 per week, which equals $297,176.36 incremental profit a year! This data suggests it is important to start manufacturing on new plastic rings as soon as the new equipment becomes available; the projected time frame is September.

The additional profit between plastic and steel rings derives from the decrease in manufacturing cost.

Table 2

A break down of expenditures points to a large gap in manufacturing costs between plastic and steel. Variable costs, material and direct labor, are reduced $435.25 by converting to plastic as well as a $393 reduction of departmental and administrative fixed costs.

Table 3

*Product line profit differs slightly from incremental analysis calculations due to decimal rounding.

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Table 2

Table 3

*Product line profit differs slightly from incremental analysis calculations due to decimal rounding.

After reviewing Table 3, it’s important to note the difference in contribution margin ratios between plastic and steel. Plastic has a significantly higher product-line profitability compared with steel. For every dollar in sales of plastic, precision Worldwide earns $.94, while Steel earns only $.62 of every dollar. Both Incremental analysis and product line profitability, support the idea that plastic is important to improving profitability for Precision Worldwide.

Aside from increased incremental profit and lower incremental cost, consumers need to know our company supplies the best product on the market. In terms of the French market, once customers realize they can purchase plastic rings that last four times longer than Henri Poulenc, our current business will be lost to the competition. In regards to the remaining 90% of the PVI’s market, production of plastic rings will corner the market and increase PVI’s business due to customer demand of a better product.

Investment of $7,500 in new equipment is a small price to pay for making a product that customers appreciate. This origination cost, once purchased, will become a fixed cost for the company, therefore should not be included in incremental analysis.

The company, which up to this point has been focused on the cost of the steel, has factored it into their decision to remain in the production of steel rings. This focus is misguided. Cost of the steel is a sunk cost, which should not be figured into this decision. The profit on the plastic rings is more than four times the profit of steel rings. Data depicted from incremental analysis and product-line profitability should be the factor driving the company’s decision.

After manufacturing begins, the marketing department will start advertising and educating customers about Precision Worldwide’s new, longer lasting rings. There will be a slight increase in marketing costs to educate customers about the benefits of the plastic rings. This advertising/marketing cost will slightly increase fixed costs and minimally affect product profit. It is important for Worldwide to become a reliable producer of the best, most innovative product on the market. This will allow them to achieve brand name recognition, which will help them hold their current clientele, while attracting new customers.

Lower manufacturing costs of plastic rings results from a reduction in direct labor, which creates an issue of excess labor for the company. The current company policy avoids laying people off. While this is a noble practice, the future in plastic rings won’t make this policy realistic. Looking into other manufacturing ventures would be one way to avoid layoffs.

Though, it must be noted plastic rings last four times as long as traditional steel rings. This will impact the number of rings sold per week, because demand will decrease by 75%, rings sold per week will no longer be 6.9 but 1.73, (6.9*.25).

Table 4

If demand drops for plastic rings, incremental revenue decreases significantly from Table 1. Table 4 shows the differences in incremental analysis in these two scenarios.

Revenue will fall by $6,979.50 if demand decreases for plastic rings. Incremental costs will be cut by an additional $1,445.69, but profit will fall by $5,533.71.

These calculations are important to recognize that if demand drops, due to the durability of plastic rings, it is important to attract new customers to continue to drive sales.

Conclusion:

Precision Worldwide should immediately halt production of the steel rings and invest $7500 to purchase the equipment necessary to begin production of plastic rings in September. Use the excess labor to market and educate existing customers about the changeover from steel to plastic rings in 4 months. This excess labor could also be used to explore and branch into new product lines. Offer the steel rings to current customers at ¼ the current price of $1,350 or $337.50 since the plastic rings last 4 times as long. This is a loss, but is better than receiving no revenue at all for the steel rings already produced and steel rings that could be produced from the remaining raw steel.