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Digital Solutions, Inc., manufactures two component parts for the television industry:

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·       Voltage Regulator: Annual production and sales of 50,000 units at a selling price of $52.50 per unit.

·       Mother Board: Annual production and sales of 25,000 units at a selling price of $72 per unit.

Digital Solutions includes all R&D and design costs in engineering costs. Assume that Digital Solutions has no marketing, distribution, or customer-service costs.

The direct and overhead costs incurred by Digital Solutions on the Voltage Regulator and Mother Board are described as follows:

Voltage Regulator

Mother Board

Total

Direct materials costs (variable)

$1,020,000

$720,000

$1,740,000

Direct manufacturing labor costs (variable)

360,000

240,000

600,000

Direct machining costs (fixed)

180,000

120,000

300,000

Manufacturing overhead costs:

     Machining setup costs

112,500

     Testing costs

600,000

     Engineering costs

480,000

          Manufacturing overhead costs

$1,192,500

Total costs

$3,832,500

Digital Solution’s management identifies the following activity cost pools, cost drivers for each activity, and the costs per unit of cost driver for each overhead cost pool:

Activity

Description

Cost Driver

Cost per Unit of Cost Driver

Setup

Preparing the machine to manufacture a new batch of products

Setup hours

$30 per setup-hour

Testing

Testing components and final product (each unit is tested individually)

Testing hours

$2.40 per testing hour

Engineering

Designing products and processes and ensuring their smooth functioning

Complexity of product and process

Costs assigned to products by special study

Over a long-run time horizon, Digital Solution’s management views direct materials costs and direct manufacturing labor costs as variable with respect to the units of Voltage Regulator’s and Mother Board’s produced. Direct machining costs for each product do not vary over this time horizon and are fixed long-run costs. Overhead costs vary with respect to their chosen cost drivers. For example, setup costs vary with the number of setup-hours. Additional information is as follows:

                                                                                      Voltage Regulator                               Mother Board

Production batch size                                                    500 units                                           200 units

Setup time per batch                                                      15 hours                                             18 hours

Testing and inspection time per 

unit of product produced                                               2.5 hours                                            5 hours

Engineering costs incurred on each product              $200,000                                            $280,000

Digital Solutions is facing competitive pressure to reduce the price of the Voltage Regulator and has set a target price of $48, well below its current price of $52.50. The challenge for Digital Solutions is to reduce the cost of the Voltage Regulator. Digital Solution’s engineers have proposed a new product design and process improvements for the “New Voltage Regulator” to replace the Voltage Regulator. The new design would improve product quality, and reduce scrap and waste. The reduction in prices will not enable Digital Solutions to increase its current sales. (However, if Digital Solutions does not reduce prices, it will lose sales.)

The expected effects of the new design relative to the Voltage Regulator are as follows:

·       Direct materials costs for the New Voltage Regulator are expected to decrease by $2.50 per unit.

·       Direct manufacturing labour costs for the New Voltage Regulator are expected to decrease by $0.70 per unit.

·       Time required for testing each unit of the New Voltage Regulator is expected to be reduced by 0.5 hours.

·       Machining time required to make the New Voltage Regulator is expected to decrease by 20 minutes. It currently takes one hour to manufacture one unit of Voltage Regulator. The machines are dedicated to the production of the New Voltage Regulator.

·       The New Voltage Regulator will take 7 setup-hours for each setup.

·       Engineering costs are unchanged.

Assume that the batch sizes are the same for the New Voltage Regulator as for the Voltage Regulator. If Digital Solutions requires additional resources to implement the new design, it can acquire these additional resources in the quantities needed. Further assume the costs per unit of cost driver for the New Voltage Regulator are the same as those described for Voltage Regulator.

Required

1)     Develop full product costs per unit for the Voltage Regulator and Mother Board, using an activity-based product costing approach. (25 marks)

2)     What is the markup on the full product cost per unit for the Voltage Regulator? (8 marks)

3)     What is Digital Solution’s target cost per unit for the New Voltage Regulator if it is to maintain the same markup percentage on the full product cost per unit as it had for the Voltage Regulator? (10 marks)

4)     Will the New Voltage Regulator design achieve the cost reduction targets that Digital Solutions has set? (21 marks)

5)     What price would Digital Solutions charge for the New Voltage Regulator if it used the same markup percentage on the full product cost per unit for the New Voltage Regulator as it did for the Voltage Regulator? (6 marks)

6)     What price should Digital Solutions charge for the New Voltage Regulator, and what next steps should Digital Solutions take regarding the New Voltage Regulator? (10 marks)

7)     Provide a recommendation given the case facts and your analysis. (10 marks)

8)     Pay attention to detail within your answers in terms of spelling, grammar, and formatting. (10 marks)

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