Question

Petrell Inc. is a wholesale distributor supplying a wide range of high-end cooking knives for the professional chef. Petrell has an enviable reputation for quality of its products. The demand for Petrell ’s products is so great that at times Petrell cannot satisfy the demand and must delay or refuse some orders, in order to maintain its production quality. Additionally, Petrell purchases some of its products from outside suppliers in order to meet the demand. These suppliers are carefully chosen so that their products maintain the quality image that Petrell has attained. The Petrell production facilities are highly automated, with more than 100 robots performing many steps in the knife-making process. The basic shape and the integral bolster of forged blades are precision forged in a die at 2200 ℉ (1200 °C) and then hardened at 1920 ℉ (1500 °C). Petrell forged knives have more than 40 steps in their manufacturing process. The company has a Robotics Department that is currently manufacturing the professional chef knives for the cooking set. Petrell is able to manufacture and sell 150,000 knife sets annually, making full use of its robotic capacity. Presented below are the selling price and costs associated with

Petrell 's professional chef knives:

Selling Price per Set: $1000

Cost per Set:

Polypropylene Handle $25 High carbon stainless steel- forged 300 Robotics time ($50/hr) 150 Direct Labor 200 Manufacturing overhead 150 Selling and admin. cost 40

Total costs 865

Profit per set of chef knives $135

Because Petrell believes it could sell 200,000 sets of chef knives annually if it had sufficient manufacturing capacity, the company has investigated the possibility of purchasing the knives for distribution. Bon Appetit Inc., a steady supplier of quality products, would be able to provide 30,000 sets of knives per year at a price of $850 per set delivered to Petrell 's facility. With the explosion of the healthy eating and organic food phenomenon and the current open concept in housing with the kitchen as the center of the home, there is a significant uptick in the “at home foodie”. Petrell 's product manager has suggested that the company could make better use of its Robotics Department by manufacturing high-end cutlery for the at-home market. In fact, to support his position, the product manager has a market study that indicates an expanding market for high-end cutlery for the home market and a need for additional suppliers. The product manager believes that Petrell could expect to sell 75,000 sets of high end home-market cutlery annually at a price of $500 per set. The estimated costs to manufacture the cutlery is presented below.

High-End Cutlery data

Selling Price per Set: $500

Cost per Set:

Molded Plastic $25 Carbon Steel – laser cut 100 Robotics time ($50/hr) 50 Direct labor 75 Manufacturing overhead 50 Selling and admin. cost 20

Total costs 320

Profit per set of home-market knives $180

The home market knife sets are laser-cut from a stainless-steel plate and have only 14 steps in their manufacturing process. Other information pertinent to Petrell 's operations is presented below. Purchased products – other costs: Total fixed and variable selling and administrative costs for the purchased knives would be $12 per set. Selling and Administrative costs: An allocated $8 fixed overhead cost per unit is included in the selling and administrative cost for all purchased and manufactured products. Manufacturing overhead: The overhead included in the above costs is a combined variable and fixed amount. In the Robotics Department, Petrell uses Robotics hours as the application base for manufacturing overhead. Included in the manufacturing overhead for the current year is $6,750,000 of fixed, factory-wide manufacturing overhead in the Robotics Department.

1) Maximize Petrell Inc.'s profitability, recommending which product or products should be manufactured and/or purchased. Support your recommendation by an analysis that will show the associated financial impact. Compare the current product manufacturing decision with your alternatives. Compute profitability through contribution margin using a variable costing income statement. Hint: This is a Short-term decision. In the short run, fixed costs remain the same. The financial comparison should only include variable costs. Hint: The first step is to separate all costs into their respective fixed and variable components. Overhead and Selling and admin. costs are mixed costs.

2) Recommendations should include the strategic consideration.

Answer 1

Based on detail provided Robotic Process availability is key for decision making & it seems that it can't be expanded otherwise it would have been mentioned. In view of this we have maximum 450,000 robotic processing hours availability which needs to be deployed in optimal way to maximise profit. It is also assumed that there is no constraint on other factors i.e. labor and material.

The contribution per robotic machine hour in Cutlery business is 180 per hour whereas for knife manufacturing it is 63 per hour. Hence it would be prudent to utilise Robotic process capacity first towards Cutlery business. However Cutlery business volume is not in a position to utilise full capacity of robotic machine processing hours hence the balance available robotic machine hours needs to be utilised for knife manufacturing.

Further knife manufacturing based on balance robotic hours will be just 125000 units hence the purchase option also works. In addition company is recommended to search another supplier as there will be still selling capacity unutilised for knife by 55000 units.

The fixed cost are not relevant for decision making as they do not change what business you carry. In view of this the aim would be to maximise contribution (Selling price - Variable Cost)

Below will be strategical proposition :

Final Strategic Decision	Units	Robotic Hours	Contribution per Unit	Total Contribution
Cutlery Business	75,000	75,000	180	13,500,000
Knife Manufacturing Business	125,000	375,000	188	23,500,000
Knife Purchase from Bon Appetit Inc	30,000	-	146	4,380,000
Total		450,000		41,380,000

Working Notes :

Bifurcation of Manufacturing Ovehead to fixed and Variable
Number of Units Produced (a)	150,000
Manufacturing ovehread per unit (b)	150
Total Manufactureing Overhead (c=a*b)	22,500,000
Less: Fixed Overhead (d)	6,750,000
Variable Overhead (e=c-d)	15,750,000
Variable Manufacturing overhead per unit (f=e/a)	105
Fixed Manufacturing overhead per unit (g=d/a)	45

Bifurcation of Selling and Admin Ovehead to fixed and Variable
Number of Units Produced (a)	150,000
Selling and Admin ovehread per unit (b)	40
Total Selling and admin Overhead (c=a*b)	6,000,000
Less: Fixed Overhead (d)	1,200,000
Variable Overhead (e=c-d)	4,800,000
Variable Selling and admin overhead per unit (f=e/a)	32
Fixed selling and admin overhead per unit (g=d/a)	8

Knife Manufacturing Business
Selling price (a)	1,000
Polypropylene Handle	25
High Carbon Stainless Steel - Forged	300
Robotic Time (3 Hour)	150
Direct Labor	200
Variable Manufacturing Overhead	105
Variable Selling and Admin Overhead	32
Total Variable Cost (b)	812
Contribution Margin (c=a-b)	188
Fixed Manufacturing Overhead	45
Fixed Selling and admin cost	8
Net Profit	135
Contribution per Robotic Hour (c/robotic hours)	63

Evaluation of Bon Appetit Inc - Proposal
Selling price (a)	1,000
Variable Cost
Purchase Price	850
Variable selling and administrative cost (12-8)	4
Contribution Margin per unit	146

Evaluation of High End home Cutlery
Selling price (a)	500
Variable Cost
Molded Plastic	25
Carbon Steel – laser cut	100
Robotics time (1 Hour)	50
Direct labor	75
Variable Manufacturing Overhead (50-45)	5
Variable Selling and Admin Overhead (20-8)	12
Total Variable Cost (b)	267
Contribution Margin (a-b)	233
Fixed Manufacturing overhead	45
Fixed Selling and admin. cost	8
Net Profit	180
Contribution per Robotic Hour	180