Pop-In Burgers owns numerous restaurants and food production facilities. The com
ID: 2472125 • Letter: P
Question
Pop-In Burgers owns numerous restaurants and food production facilities. The company routinely evaluates proposals to drive operational efficiency. Four such proposals are currently under review. One entails the suggestion to close the unprofitable store in Canyon City. Another is to outsource the acquisition of onions, rather than growing them. Another proposal is to sell packaged beef to a non-competing restaurant chain under a private label. The final proposal is to scrap packaging material that is printed with an old logo. Mi- chelle Euray is controller for Pop-In Burgers and is reviewing staff-prepared reports for each proposal. The reports are summarized as follows:
Canyon City Proposal: The Canyon City store should be closed. The company is a consistent money loser. Below is an income report for the Canyon City store for the past year. Half of the fixed expenses relate to facilities rent under a 20-year non-cancelable lease. The lease costs cannot be avoided, and the location is not able to be subleased to another user.
Pop-In Burgers owns numerous restaurants and food production facilities. The company routinely evaluates proposals to drive operational efficiency. Four such proposals are currently under review. One entails the suggestion to close the unprofitable store in Canyon City. Another is to outsource the acquisition of onions, rather than growing them. Another proposal is to sell packaged beef to a non-competing restaurant chain under a private label. The final proposal is to scrap packaging material that is printed with an old logo. Mi- chelle Euray is controller for Pop-In Burgers and is reviewing staff-prepared reports for each proposal. The reports are summarized as follows:
Canyon City Proposal: The Canyon City store should be closed. The company is a consistent money loser. Below is an income report for the Canyon City store for the past year. Half of the fixed expenses relate to facilities rent under a 20-year non-cancelable lease. The lease costs cannot be avoided, and the location is not able to be subleased to another user.
sales 1400000
variable 1000000
cm 400000
fixed 650000
income (loss) 250000
Outsource Onions Proposal: The company spent a total of $2,000,000 producing onions during the past year. The onions were grown on a company-owned farm. A vender has offered to supply a similar quantity and grade of onions for $2,200,000. Staff recommends continuing to grow onions because the proposed purchase price is 10% higher than the cost of growing onions. Staff believes it is inappropriate to consider that the onion farm could be leased to another farmer for $350,000, if it is diverted from onion production.
Sell Packaged Beef Proposal: The other company has offered to buy packaged beef at $4 per pound. The packing plant is well below full capacity and can accommodate the request without incurring any additional fixed costs. However, staff believes it would be inappropriate to price the beef below its own internal cost of $4.50 per pound, which consists of raw materials ($2.50), direct labor ($0.75), variable factory overhead ($0.25), and fixed factory overhead ($1.00). This transaction would result in no material amount of added selling, general, or administrative costs.
Scrap Packaging Material Proposal: The company spent $500,000 on packaging material that is imprinted with an old logo. It is unlikely this material will ever be used. However, staff recommends against scraping because this will result in an immediate charge against net income. It costs only $2,000 per year to store the material.
Provide a decision for each of the projects.
Explanation / Answer
Canyon City Proposal
The Canyon City store should not be closed. It is so because, half of the fixed costs which are related to lease can be avoided and the company will continue to incur that cost irrespective of whether the store is operated or not. In such a case, the company will have to bear a loss of $325,000 (650,000/2) as against the current loss of $250,000 (if the store is not shut down). Therefore, if the store is closed, there will be a decrease in net income by $75,000 (325,000 - 250,000).
_________
Outsource Onions Proposal
Considering the fact that the land could be leased to another farmer for $350,000, the company should purchase onions from the outside supplier. It is so because, the total cost of producing onions will be $2,350,000 (2,000,000 + 350,000) where $350,000 is the opportunity cost of not leasing the land to another farmer. Therefore, the total cost of production of $2,350,000 is higher than the total cost of buying the onions ($2,200,000) from an outside supplier. There would be in an increase in net income by $150,000 if onions are bought from outside supplier. The management should its decision on the basis of practial and relevant information and not on the basis of beliefs of its staff.
_________
Sell Packaged Beef Proposal
The company should go ahead with the proposal. It is so because the company will be able to generate additional income of $.50 per pound (4-2.5-0.75-0.25) from this proposal. The fixed cost per pound is not a relevant cost as the company is operating below its full capacity and can easily execute the order from the other company without incurring any additional costs.
_________
Scrap Packaging Material Proposal
The packaging material should be scrapped as it is unlikely that it will ever be used by the company. There is no point in incurring additional costs of $2,000 per year with respect to something which is not going to be used. The company can infact use the amount realized from scrapping the packaging material for some other productive purposes. Also, the space used by the packaging material can be used for storing some other inventory items which are of use to the company on a daily basis.