Please Note: I only need answers to question 3 The Falco Group is a holding company with majority ownership of several b

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Please Note: I only need answers to question
3
The Falco Group is a holding company with majority ownership of
several business-to-business and business-to-consumer firms. The
company’s flagship consumer holding is the wholly-owned Falco
Scooter Company. It makes and sells two scooter models: the
City-100 and the Super-300.
The City-100 model has a maximum speed of 50 mph;
consequently, it is not allowed on most expressways. The higher-end
Super-300 uses a larger, more powerful engine and enhanced
safety systems; with its maximum speed of 79 mph, it is approved
for expressway riding in many areas.
The market for the City-100 scooter is highly
competitive. Many competitors offer essentially identical scooters;
the current prevailing market price is $660. At this price, Falco
can sell any number of City-100’s (our current annual
estimate is 5,000 – 6,000 unit sales).
The market for the Super-300 model is an oligopoly;
Falco expects to sell 1,000 Super-300’s per year at the
current price of $3,000.
Falco Scooters has a single state-of-the-art assembly facility,
where both scooter models are made from components sourced from a
small number of suppliers. One of the key strategies of the Falco
Group is to strive to maximize capacity utilization. Consequently,
the scooter manufacturing facility operates at its maximum
practical capacity; the capacity constraint is equipment, measured
in machine hours (MHs). The two models are assembled using the same
employees and equipment. Increasing equipment capacity at Falco
Scooters is not currently an option.
The key difference between the two scooter models is
Super-300’s more powerful engine. Currently, the engine is
purchased from an outside supplier for $300 per unit.
As part of its long-term growth strategy in the
business-to-business segment, the Falco Group recently acquired
Scorpion Motors – a small manufacturer of motorcycle
engines. Scorpion Motors makes and sells two engine models:
Standard and Deluxe.
Scorpion Motors’ engine-manufacturing plant operates at its
maximum practical capacity; the capacity constraint at the engine
plant is skilled labor, measured in direct-labor hours (DLHs). For
various legal and strategic reasons, increasing labor capacity at
Scorpion Motors is not an option. On the other hand, there is
significant equipment excess capacity at Scorpion Motors, but this
is not an issue the Falco Group plans to address in the near
future. The same employees manufacture both engine models using the
same equipment.
The market for the Standard engine is highly
competitive; at the prevailing market price of $75, Scorpion Motors
can sell any number of Standard engines (our current
annual estimate is 20,000 – 25,000 annual unit sales).
The Deluxe engine is made for a single external
customer, MG Motorcycles, under a long-term contract requiring
Scorpion to deliver 2,500 Deluxe engines per year. The
Deluxe uses a design developed and patented by MG
Motorcycles; Scorpion Motors is not allowed to sell this engine to
any other client.
A recent review of potential internal synergies revealed that a
modified version of the Scorpion Motors’ Deluxe engine
could be successfully used by Falco Scooters for the
Super-300, instead of the engine currently bought from the
outside supplier. MG Motorcycles agreed to allow Scorpion to make
this Modified Deluxe for Falco Scooters for a licensing
fee of $30,000 per year. Modifications to make the Deluxe
fit on the Super-300 will require additional
direct-materials (DM) costs at Scorpion Motors of $30 for each
Modified Deluxe. Neither costs nor volumes of the
Deluxe units made for MG Motorcycles will be
affected.
Additional information, collected from the two divisions’
normal-absorption reporting systems, is below:
2 Selling price$660$3,000Direct Materials (includes
engine)$420$1,260Machine Hours14Direct Labor5DLHs @$30per DLH20DLHs
@$30per DLHVariable Overhead Allocation$6per DLH$6per DLHFixed
Overhead Allocation$9per DLH$9per DLHFalco Scooter Company,
per-unit informationCity-100Super-300
Selling price$75$300Direct Materials$15$120Machine Hours13Direct
Labor1DLH @$30per DLH2DLHs @$30per DLHVariable Overhead
Allocation$15per DLH$15per DLHFixed Overhead Allocation$3per
DLH$3per DLHScorpion Motors, per-unit
informationStandardDeluxe
Required. You are a CPA internal consultant
employed by the Falco Group, helping Falco Scooters address the
issues below. Ignore taxes. Keep in mind that both Falco Scooter
Company and Scorpion Motors are wholly-owned subsidiaries of the
Falco Group.
1. Falco Scooters expects to sell 1,000
Super-300’s annually. From the point of view of the Falco
Group, should the engines for Super-300’s be purchased
from the external supplier or made internally, by Scorpion Motors?
What is the total financial impact on Falco Group if Falco Scooters
switches to in-sourcing the engines?
2. Falco Scooters’ marketing department
estimates that if the selling price on Super-300’s is
lowered to $2,925 per unit, annual sales of this model will
increase to 1,350 units. Should the company lower the price? How
should they obtain the engine (make at Scorpion Motors or buy from
outside supplier) under this alternative pricing strategy? Provide
full financial analysis of the various alternatives.
3. Falco Scooters’ divisional managers’ bonus
incentives are tied to the division’s net operating income (NOI,
computed using GAAP). For various reasons, the division does not
appear to be on track to meet the NOI target needed to earn bonuses
for divisional managers. Falco Scooters’ controller notes that the
unit margins on City-100’s are so low that the division
would increase its NOI if its stops producing and selling
City-100’s and instead make Super-300’s for
inventory. a. While City-100’s unit contribution margin is
low, it is still positive. Conceptually, how can the controller’s
proposal – to stop producing and selling City-100’s and
instead make Super-300’s for inventory – provide the
division with a higher NOI?
b. Comment on the controller’s proposal. Are there any problems
with this proposal? Is it a good idea from the point of view of the
Falco Group’s shareholders?