Memo To: Mr. Richard Merton, President, Merton Truck Company From: Jane Doe, Consultant Date: October 18, 2013 Re: Merton Truck Company Financial Performance and Product Mix Analysis Introduction: The following information in the memo includes the product mix of Model 101 trucks and Model 102 trucks that maximizes monthly contribution. Whether or not the company should “rent” additional capacity, the maximum amount the company should pay for “rent,” and the maximum number of hours of capacity that can be “rented.
” As well as the consequences of imposing the product mix constraint of producing at least three times as many Model 101 trucks than Model 102 trucks. The overall goal of the analysis was to provide the role the product plays on the company’s financial performance. After working with the company’s comptroller, sales manager, and production manager, I have been able to develop some options and a recommendation. Merton Truck Company Current Situation: Currently, Merton Truck Company specializes in manufacturing two models of trucks, Model 101 and Model 102.
The manufacturing processes of the trucks are grouped into four departments; Engine Assembly, Metal Stamping, Model 101 Assembly, and Model 102 Assembly. Even though some of the production lines are already operating at full capacity, the financial position of the company is still lacking. The Model 101 trucks do not seem to be making a profit. Data Used in Analysis: Merton Truck Company provided the data used in the analysis. The data that was found pertinent to this case included: Model 101 trucks have a selling price of $39,000, while the Model 102 trucks are sold for $38,000 During the first six months of 2013, Merton Truck Company had a monthly output of 1,000 Model 101 trucks 1,500 Model 102 trucks. The supplied variable costs per unit and fixed costs per unit were used to calculate the contribution for each model. Contribution is defined as revenue (selling price) minus variable costs, (for calculations, please refer to appendix 1).
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The data provided by the company included the fixed costs; however, the fixed costs should not be considered when calculating the contribution for each model. The contribution was found to be $3,000 for Model 101 trucks and $5,000 for model 102 trucks.
The company also supplied the capacity limits per month and production requirements per unit. These limits and requirements were used to set the constraints that were used in the calculations to find the optimal product mix. The constraints are total machine-hours available per month and machine-hours required per truck. Method of Analysis: The method used to analyze the data was Linear Programming (LP).
LP is a mathematical technique that is used to help make decisions on how to best utilize the company’s resources.
LP uses an objective function, a mathematical statement of the company’s goal, and constraints, restrictions placed on the resources available to the company, to help find the optimal solution. The objective function for Merton Truck Company was to maximize the monthly contribution. The constraints, (refer to appendix 2 for list of constraints), were set in order to find the optimal product mix that would satisfy the objective function. The solutions were found by entering the data into a Microsoft Excel spreadsheet. Once the data had been entered, the Solver function was run. Solver provided the solutions used in the analysis.
Optimal Product Mix: Based on the results of the analysis, the optimal product mix for Merton Truck Company is to produce 2,000 Model 101 trucks and 1,000 Model 102 trucks. This product mix will yield a maximized monthly contribution of $11,000,000 (refer to graph 1).
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Assuming the equipment can handle additional hours of production time, the company would be able to increase their capacity limits for both the engine assembly department and metal stamping department. The engine assembly capacity can be increased up to 500 machine-hours. For each additional machine-hour, Merton would see a $2,000 increase in revenue.
The metal stamping capacity can also be increased up to an additional 500 machine-hours. The company could see an additional $500 increase in revenue per each additional machine-hour added. “Renting” Capacity: The production manager had made the suggestion of either purchasing Model 101 or Model 102 engines from an outside supplier in order to relieve the capacity problem in the engine assembly department. It was also suggested that the company could take responsibility for furnishing the necessary materials and engine components, as well as reimbursing the outside supplier for labor and overhead.
The maximum amount the company could pay for “rent” is $2,000. The maximum number of hours of capacity that should be rented is 500. Consequences of Producing Three Times More Model 101 Than Model 102: The suggestion of producing at least three times as many Model 101 trucks as Model 102 trucks adds an additional restriction to the previous list (See Appendix 3 for new constraints).
The result of the analysis provides a new product mix to consider as an optimal solution. Based on the results, Merton Truck Company should produce 2,250 Model 101 Trucks and 750 Model 102 trucks (refer to graph 2).
This product mix would produce a maximized contribution of $10,500,000. The analysis also shows that the company could lose $500 in contribution for each additional machine-hour of Model 101 and Model 102 assembly. Recommendations: Based on the results of the analysis, the recommended optimal product mix that will maximize the monthly contribution is for Merton Truck Company to produce 2,000 Model 101 trucks and 1,000 Model 102 trucks. This recommendation will maximize the monthly contribution and help to increase the overall financial performance of the company.
Merton Truck Company may also want to consider the option of “renting” additional capacity. By “renting” the additional capacity, the company would be able to increase the contribution. For each machine-hour of capacity rented, the company could earn up to an additional $2,000 in revenue, up to 500 available machine-hours. The company should not consider the option of producing three times as many Model 101 trucks than Model 102 trucks. Instead of generating revenue for the company, this option would cause the company to loose revenue. Benefits/Risks of Analysis:
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One main benefit of using LP in the analysis is that it makes use of all the available resources, while evaluating all the possible alternatives. This benefit allows for the company to better utilize their resources, and to determine the optimal product mix. There are a few risk factors Merton Truck Company may choose to consider. One such factor includes the demand levels for Model 101 and Model 102 trucks. The company may also want to consider the availability of the materials and the labor needed to produce the two models of trucks.
Due to the demand levels and the available resources, Merton Truck Company may need to adjust the capacity limits, which would ultimately change the optimal product, mix and maximized monthly contribution. Appendices: Appendix 1: Contribution Calculations Contribution = Revenue (Selling Price) – Variable Costs Model 101 Model 102 Selling Price $39,000 $38,000 Variable Costs: Direct Materials ($24,000) ($20,000) Direct Labor ($4,000) ($4,500) Variable Overhead Per Unit ($8,000) ($8,500) Total Contribution $3,000 $5,000
