Question

Complete one of the following, either 1a or 1b

Problem 4a

Ronald’s Refrigeration Repair located in Tampa, Florida provides service to restaurant customers. He has always had the policy of letting his employees have 6 holidays off each year (New Year’s Day, Memorial Day, July 4th, Labor Day, Thanksgiving, and Christmas). However, he has also discovered that these are the days when restaurants seem to be the busiest and have refrigeration breakdowns. As a result he is considering paying an emergency skeletal crew time and a half overtime rather than giving them the days off.

Ronald estimates that if he does this, he can generate $2,500 revenue for each of these 6 days. The incremental cost for 2 repair personnel will be $65 per hour for 8 hours per day plus daily costs of: $500 for parts, $300 for transportation costs, and $250 for dispatcher staff. These costs do not include a share of monthly rent or depreciation related to equipment.

Although Ronald would like to maintain his current holidays off policy, he would like to know the opportunity cost of this.

1) Present Ronald with an estimate of the opportunity cost and

2) Explain why you do not have to consider rent or depreciation in the estimate.

3) What other considerations should Ronald consider before making a decision  

Problem 4b

Break-even time. Hampton Corporation’s research and development department is presenting a proposal for new product research. The new product will require research, development, and design investments of $6.0 million (discounted cash flow). Sales will generate an annual discounted net cash flow of $2.0 million starting in Year 5.

Required:

a. Calculate the break-even time for the new product.

b. What can Hampton Corporation do to reduce break-even time?

Answer 1

Problem 4a:

Requirement 1: Compute opportunity cost as follows

Particulars	Amount	Amount
Revenue		$2,500
Deduct: Incremental costs
Labor cost (2 personnel × $65 × 8 hours)	$1,040
Parts cost	$500
Transportation cost	$300
Dispatcher staff cost	$250
Total incremental costs		$2,090
Incremental income		$410
×   Number of holidays		6
Opportunity cost		$2,460

Requirement 2: Rent and Depreciation costs not incremental costs as these costs are incurred whether the company opens or shuts the repair shop during the holidays.  

Requirement 3: The company should consider the impact of its decision on the morale of its employees as this decision may result in increased costs to company due to increased employee turnover.

Problem 4b:

Requirement a: Compute break-even time as follows

Break-even time = (Investment ÷ Annual discounted cash inflow) + Time from project approval to Sales revenue generation

= ($6 million ÷ $2 million) + 4 Years

= 6 Years

Requirement b:  The company should explore the ways to shorten the new product development time so that it can recover the investment in new product development at the earliest possible time.