F5: Shutdown decision

mark057

Hello again everyone. This paper is driving me crazy.

I've just attempted a shut down question in F5.

The question asks: Calculate whether or not it is worthwhile ceasing production on product TD now rather than
waiting 12 months?

The answer provided the following calculation:

By ceasing production now.

Lost contribution ($71 000)
Saved contribution $12 000
Labour ($3 700)
Lost discount ($19 000)
Sublet income $12 000

Net cash flow ($69 700)

I answered my calculation by showing the relevant costs and income in one column in the event the TD is ceased now and the relevant costs and revenues in another column for deferring for 12 months.

I'm confused by the books answer in that it calculates the net cash flow only from the perspective of ceasing the product now, and declares it should not be ceased now, without calculating the net cash flow if the product
was ceased in 12 months.

Is that decision based on the fact ceasing the product now will lead to a loss of $69 700? Could it not be possible the company could lose more if the decision is delayed for 12 months?

I'm confused. Any thoughts?

Mark

SandyHood

Look at your own answer again.
You ought to reach the same conclusion.

The approach that you typed onto the thread is one I wouldn't recommend to a newcomer to this subject.
It shows the incremental values. The differences between the two alternatives.

For example staying open for the next 12 months will bring in revenue as follows:
($10) per unit x 1,200 units = Saving of the negative contribution if we keep on producing the TD = $12,000
If we stop selling TDs we will lose 5% of WM and DW sales ($80 x 5,000 and $170 x 6,000) = loss of $71,000

mark057

Thanks for that Sandy.

I personally broke my answer into two parts.

I calculated the following based on stopping the TD now:

Lost contribution: $59 000 ($71 000 - $12 000)
Redundancy cost: $6000
Recruitment cost: $1200
Discount lost: $19 000
Short term lease: $(12000)
Total cost: $73200

Then calculated the following based on deferring stopping TD for 12 months:

Lost contribution: $59 000 ($71 000 - $12 000)
Redundancy cost: $3500
Discount lost: $19000
Total cost $81 500

Surely the decision should be to cease production of the TD now rather than in 12 months because it will cost less? Is that logical or is there something wrong with my analysis?

Many thanks for your help.

Mark

SandyHood

Yes
Stop production now
Do not trade for the next year

mark057

Well the BPP text book answer just shows the net cashflow calculation of $69 700.

It's exact wording in the answer is 'it is not worthwhile to cease production of the TD now rather than waiting 12
months'.

How do they figure that conclusion????

I'm seriously concerned about this BPP Practice and revision kit book. Aspects of some of the questions are not even covered in the study text I purchased.

I'm thinking of ringing BPP to complain.

Mark

SandyHood

Apology

I made the following statement in an earlier post

Yes
Stop production now
Do not trade for the next year

I have now done the sum myself and must apologise to you. I think they [size=+1] continue TD production for 12 months[/size]

I answered my calculation by showing the relevant costs and income in one column in the event the TD is ceased now and the relevant costs and revenues in another column for deferring for 12 months.

I found that if the TD is produced for another 12 months Stay Clean would generate a profit of $1,404,500.
If production ceases immediately the profit for the period would only be $1,334,800
A difference of $69,700
Attachment not found.

This is a copy of an excel file in a word doc as excel cannot be uploaded at the moment.

SandyHood

Mark057

I recommend that you master this technique. Look at the examiner's feedback on the task:

Question 5 (a)was a fairly straightforward shutdown decision with a tricky bit involving the calculation of bulk purchase discounts. Most candidates adopted the approach of doing two calculations: one considered the financial position if the production of TDs ceased immediately; the other considered the position if production stopped in twelve months. This approach was absolutely fine as long as candidates didn’t include figures as costs in one calculation and then as savings in the other. For example, if production ceased now the factory space could be leased out for $12,000 per annum.
Many answers showed this as income in the ‘cease now’ calculation but then also as a cost in the ‘stop in 12 months’ calculation. This double counting was wrong and wouldn’t have been given credit. The same kinds of mistakes were made with other amounts, such as the redundancy and retraining costs. This demonstrates a lack of understanding of relevant costing decisions and it is clearly an area that needs to be revisited.

I am very interested in this comment [size=+1] This demonstrates a lack of understanding of relevant costing decisions and it is clearly an area that needs to be revisited [/size]

In other words [SIZE=+1]EXPECT THIS IN AN EXAM SOON.[/SIZE]