Question: Pyramid Products manufactures a large number of
Pyramid Products manufactures a large number of home and commercial cleaning products at its
plant in Oshkosh, Wisconsin. This plant, which employs about 450 people, produces floor waxes,
cleaners, bathroom and kitchen cleaners, aerosol air fresheners, disinfectants, and laundry detergents. The products are sold under their own brand name (Pyramid) to supermarkets and home and garden centers. Over time, competition from national brands and price pressure from mass merchandisers such as Wal-Mart have eroded Pyramid sales to the point that the Oshkosh plant has substantial excess capacity—approaching 40 percent of the plant’s historical capacity 25 years ago when the plant was built. Pyramid has tried a variety of strategies to increase sales of its existing products, but so far none seem to be yielding dramatic effects.
In an effort to build volume in the plant and to increase the demand for its existing products, management has begun an acquisition strategy and engaged an investment banking firm to find suitable acquisition targets. A suitable target would be in the home cleaning industry with products complementary to Pyramid’s, with production that could be shifted to the Oshkosh plant. A complementary product would not duplicate existing Pyramid products and would have a distribution channel that could be used to enhance the sales of other Pyramid products. The investment banker has identified two candidates, Zapp and Kleann. Each produces a branded product for the home cleaning market and both offer
Pyramid about the same synergies in terms of increasing the demand for Pyramid’s existing products. Both could be acquired for about the same price, but because Pyramid has limited capital and limited access to the capital markets, it can acquire only one of the two companies, not both. Pyramid’s investment banker has provided the following summary data for both targets:
Besides reviewing the price and variable cost information in the preceding table, the Oshkosh plant manager and her chief financial officer have visited both Zapp and Kleann. They estimate that the Oshkosh plant will have to incur additional fixed annual overhead costs of $600,000 if Zapp is acquired and $400,000 if Kleann is acquired. These additional annual fixed costs include such items as additional leased equipment and additional personnel in quality control, engineering, and purchasing.
The Oshkosh plant uses a single plantwide overhead rate to assign plant overhead to products. Currently, the factory’s fixed overhead is $3 million and its current volume is 50,000 direct labor hours. There is negligible variable factory overhead in the Oshkosh plant. Fixed factory overhead is absorbed to products based on direct labor hours.
Required:
a. Calculate the Oshkosh plant’s current fixed manufacturing overhead rate (before the acquisition of either Zapp or Kleann).
b. Calculate what the Oshkosh plant’s fixed manufacturing overhead rate will be if Zapp is acquired. Assume that the additional fixed overhead of $600,000 needed to bring Zapp into the Oshkosh plant is added to the existing plant overhead and the total pool is assigned t all products (including Zapp).
c. Calculate what the Oshkosh plant’s fixed manufacturing overhead rate will be if Kleann Is acquired. Assume that the additional fixed overhead of $400,000 needed to bring Kleann into the Oshkosh plant is added to the existing plant overhead and the total pool is assigned to all products (including Kleann).
d. Pyramid’s management does not know what final negotiated price Pyramid will have to pay for each target. The investment banker thinks that both Zapp and Kleann can be purchased for about the same price. However, management must decide which one to pursue first. The plant manager is most interested in Kleann. She argues that her plant’s largest problem is overhead absorption. The existing products in the plant are bearing an increasingly larger charge for overhead as volume drops. Kleann, she argues, will absorb more factory overhead than Zapp because it requires three times as much direct labor hours per case and Zapp requires less additional fixed overhead than Kleann. Critically evaluate the plant manager’s argument as to why Pyramid should first evaluate Kleann rather than Zapp. Assume that both Zapp and Kleann offer Pyramid’ existing products about the same benefits in terms of new channels of distribution for Pyramid’s products.
Transcribed Image Text:
Zapp Kleann Price per case Variable cost per case $45.00 $33.00 $37.50 $27.50 Annual volume (cases) 80,000 60,000 Direct labor hours per case 0.20 0.60
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