Abstract
Organizations make decisions on a daily basis. Organizations must make decisions that are in tandem with their objectives, mission and vision. Most trading organizations are formed with the objective of making profits. In order to maximize profits businesses must maximize revenues, minimize costs or both. When faced with a decision concerning which manufacturing process to adopt, organizations must conduct a lead cost analysis to determine which alternative has a lower cost. The organization must also evaluate other non-cost factors that may influence their decision.
Introduction
Smitheford Pharmaceuticals is an organization that intends to adopt new technology. However, it has two alternatives; a low technology option and a high technology option. It is faced with the decision of determining which one is a better alternative. This paper seeks to determine the lead cost for Smitheford Pharmaceuticals between the high technology option and the low technology options for years 1, 5 and 10. It also seeks to determine the variable cost per unit of the high technology process that will make it viable in year 5.Lastly; this paper seeks to discuss other non-cost factors that may influence decentralization of manufacturing and the decision to adopt a higher technology .
Lead cost refers to comparing overall costs between various alternatives in a bid to determine which alternative has the lowest. It is normally determined for a given future timeframe before an investment is undertaken to assist the firm in deciding which alternative to undertake. Lead cost for Smitheford Pharmaceuticals between the high technology option and the low technology options for years 1, 5 and 10 will be determined as follows;
Smitheford Pharmaceuticals cost analysis.
Year 1
High technology option.
Low technology option.
$
$
Fixed cost
620,000
110,000
Variable costs
1,631,000
1,889,000
Total costs
2251000
1,999,000
Workings:
Total cost = Fixed cost + total variable costs
Variable cost = Variable cost per unit*Number of units produced.
High technology option:
Variable cost = 16.31*100,000 = 1,631,000
Total cost = 620,000+ 1,631,000=$ 2,251,000
Low technology option:
Variable cost = 18.91*100,000 = 1,889,000
Total cost = 110,000+ 1,631,000=$ 2,251,000
Lead cost.
Using the data provided, the low technology option is the lead cost in year 1 since it has a lower cost than the high technology option.
It will be lower by; 2,251,000-1,999,000 = $ 252,000
Year 5
High technology option
Low technology option
$
$
Fixed cost
620,000
110,000
Variable costs
2,772,700
3,211,300
Total costs
3,392,700
3,321,300
Working:
Total cost = Fixed cost + total variable costs
Variable cost = Variable cost per unit*Number of units produced.
High technology option:
Variable cost = 16.31*170,000 = 2,772,700
Total cost = 620,000+ 2,772,700 =$ 3,392,700
Low technology option:
Variable cost = 18.91*170,000 = 3,221,300
Total cost = 110,000+3,221,300=$ 3,321,300
Lead cost.
Using the data provided, the low technology option is the lead cost in year 5 since it has a lower cost than the high technology option.
It will be lower by; 3,392,000-3,321,000 = $ 71,000
Year 10
High technology option
Low technology option
$
$
Fixed cost
620,000
110,000
Variable costs
3,669,750
4,250,250
Total costs
4,289,750
4,360,250
Working:
Total cost = Fixed cost + total variable costs
Variable cost = Variable cost per unit*Number of units produced.
High technology option:
Variable cost = 16.31*225,000 = 3,669,750
Total cost = 620,000+ 3,669,750 =$ 4,289,750
Low technology option:
Variable cost = 18.91*225,000 = 4,250,250
Total cost = 110,000+ 4,250,000=$ 4,360,250
Lead cost.
Using the data provided, the high technology option is the lead cost in year 10 since it has a lower cost than the low technology option. It will be lower by; 4,360,000-4,289,000 = $ 71,000
The calculations show that the lead cost is low technology options in year 1 and 5. However, in year 10, the high technology option has a lower cost than the low technology option. This is because of the shift in total costs with an increase in the number of units produced. That is the fixed costs will be spread over more units. The high technology option has a significantly higher fixed costs compared to the low technology option. However, its variable costs per unit are lower. Increasing the number of units produced reduces the average fixed cost and consequently the total costs. The lower the variable cost, the shorter the transition time required to implement the high technology.
The variable cost required to justify a transition to the high technology option at year 5 can be determined as follows;
Total cost of the low technology option in year 5 = $110,000+ (18.89*170,000) = $3,321,300
The total cost of the high technology process should be less than $ 3,321,300 to make it viable.
Total cost = Fixed cost + (Variable cost per unit*units produced)
Total cost = $ 620,000 + (170,000* Vc)
But the total cost ≤ $3, 321,300
Therefore,
$170,000Vc + $620,000≤ $3, 321,300
$170,000Vc ≤ $3, 321,300 - $620,000
$170,000Vc ≤ $ 2,710,300
Vc ≤ $ 2,710,300/170,000≤ $15.89
The variable cost per unit of the high technology process should be equal to or less than $15.89 to make it viable in year 5.
The management of a manufacturing firm may consider several factors in before decentralizing the firm. These factors differ from one manufacturing firm to another depending on the product the firms produce and the aim of the firm’s management. Below are some of the factors that affect the firm’s decisions to decentralize.
Need to diversify the firm. This is when a firm is producing more than one product. The firm may consider decentralizing to allow easier and quicker management of the production process. A firm producing two goods, for example, beer and wine can decentralize and set up two separate firms. One firm will produce beer and the other wine. Diversification allows the firm to handle the productivity process in an easier and orderly way. The books of records for costs and profits will be easier to analyze since wine will have its own records while beer has its own records. Diversification will also allow easier marketing of the two products.
The functions of the different departments of a firm can be considered when decentralizing a firm. A very large firm may opt to decentralize to allow the various departments work independently to achieve one main goal by the firm. For example, the sales and marketing department can be situated near the target market to allow easier and efficient marketing. The departments of finance and personnel can remain centralized since the enable the running of basic functions of the firm.
A firm’s size and scale of operation can make the firm’s management consider decentralization. Small firms have a small operation scale hence; they can be operated centrally but still be efficient. However, large firms have many departments and several operations. Decentralization could be ideal for the large firms to enable the division of tasks and efficient flow of activities since a decentralized system has more personnel with more managers to ensure quality work .
The aim of the firm’s management is another factor in decentralization. The managers may want to retain the decision making power in the firm hence, prefer a centralized system. The managers may prefer to control the organization but leave the decision making power to other managers distributed across the various departments in the firm. In this case, they will prefer decentralization. Decentralization may also depend on the presence of capable managers who can ensure efficient production.
Firms aim at adopting the newest technology possible not only to cut down on costs. The firm could be aiming at improving its efficiency levels. Firms that adopt new technology will produce quality products at low costs, save time using the least amount of labor force. Efficiency involves faster transportation of raw materials to the firm and products to the market. The firm making pharmaceutical drugs will improve its efficiency by adopting new technology.
The firm could be guided by factors like the need to advance the product quality of the pharmaceutical drugs they produce. With high technology, the firm is able to use the efficient machinery to further process the drugs and make them be of higher quality. Products from a firm that embraces technology have an edge when competing with similar products on the market.
Another factor that influences the adoption of new technology is the quantity of the product. Use of new technology involves reduction of manual labor and increased mechanical labor. Machines are more efficient, fast, are low cost and they ensure quality. In the end, there is a larger output when new technology is used. Machines also have economies of scale where they produce more at a lower cost, and this saves the firm even more costs. Therefore, the pharmaceutical firm will look to adopt new technology in order to achieve some of its main goals in production. A firm will adopt higher technology with the aim of keeping pace with its competitors.
Break even point in units =Difference in the fixed expenses /Difference in the v.c per unit
The fixed costs are given in the data as 620,000 for the high technology option and 110,000 for the low technology
The variable costs are given in the data as 16.39 for the high technology option and 18.93 for the low technology
Break even point in units = (620,000-110,000)/ (18.89-16.31) =197,674 units
Conclusion
The calculations show that Smitheford Pharmaceuticals can minimize their costs by using the low technology option and phasing it out over time to pave a way for the new technology. The timeframe for implementing the new technology should be after the fifth year but before the tenth year. This is because that is the timeframe where the shift in overall cost occurs. However, there other non-cost factors that Smitheford Pharmaceuticals must consider when evaluating whether to adopt the low technology option or the high technology option.
References
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