KAY TIBAY LEATHER COMPANY

The KAY TIBAY Company has been producing leather goods for more than 30 years. It purchases prepared hides from
tanners and produces leather clothing accessories such as wallets, belts, and handbags. The firm has just developed a new
leather product and has prepared a 1-year production and sales plan for it. The new product is best described as a
combination billfold, key case, and credit card carrier. As company president Liz Brown has noted, "It is a super carryall
for small this-and-that." She has placed her administrative assistant, Harry Patter, in charge of the project.

Patter established that material and variable overhead for the carryall should be about P1.50 per case over the next
year, given a 5-day week and no overtime. Unit labor and machining costs, however, depend on the choice of
machine that will be used for production. Patter has narrowed the choice down to two specialized pieces of equipment.
Machine 1 is a semi-automated machine that will cut the material to the size needed for one unit and also will sew it,
install the rings and snaps, and emboss it with two types of designs. This machine costs P250, 000 and will add P2.50
per case to the average variable cost for labor and other machine-related costs. This piece of equipment has a production
capacity of 640 units per day. However, estimated downtime for maintenance and repairs is 12.5% (1/8 th of the total
time).

Machine 2 is fully automated. It cuts, sews, installs rings and snaps, and is capable of embossing the case with three
types of designs. This machine costs P350, 000 and will add P1.75 per case to the average variable cost for labor and
other machine-related costs. Machine 2 has a higher production capacity (estimated at 800 units per day) than the
semi-automated machine. However, estimated downtime is 25% (1/4th of the total time), consistent with its great
complexity.

Marketing estimates for the next year have been more difficult to project than production costs and capacity estimates.
However, P6.00 seems the likeliest selling price for the carryall. The price brings it in line with somewhat comparable
products on the market, but because the carryall offers more features than these other products, it has the potential to
outsell them. Sales volume estimates center on 140,000 units for the year, but analysis of the potential market has been
difficult because this new product is so different from the products now being sold. Patter's best estimates of sales at
P6.00 per unit and the probabilities attached to these volumes are as follows:

Sales Volume Probability

120,000 units 0.15
130,000 units 0.25
140,000 units 0.40
150,000 units 0.15
160,000 units 0.05

Given these marketing estimates and the machine capacities, the company will have to decide either to modify the
machines to increase capacity or work overtime if demand is at the higher levels. Management can make this decision
based on the first week's worth of sales, which are expected to be a good indicator of the annual sales level . Overtime
premiums would raise the costs by P1.20 per case on the semi-automated machine and by P0.90 on the fully
automated machine. Modification of Machine 1, the semi-automated one, would cost P15, 000 to meet the highest
level of sales. Modifications of Machine 2 would cost P20, 000.

Brown has directed Patter to make a decision based on first-year sales, since demand for a product such as this is
uncertain after its initial popularity passes. Kay Tibay operates on a fifty-week year because the company usually closes
down for the Christmas holidays.
1. Which machine should Kay Tibay select?
2. Should overtime be scheduled?
3. Should a machine be modified and if so, under what circumstances?
Answer:
Variables
Machine 1- Semi Automated Machine 2- Automated
P6.00 seems the likeliest selling price for the carryall
Sales volume estimates center on 140,000 units for the year
Material and variable overhead for the carryall should be about P1.50
per case
5-day week
fifty-week /year
Production capacity of 640 units Production capacity of 800
per day units per day
Estimated downtime 12.5% Estimated downtime is 25%
(1/8th of the total time) (1/4th of the total time)
Machine costs P250, 000 and Machine costs P350, 000 and
will add P2.50 per case will add P1.75 per case
Overtime premiums would Overtime premiums would raise
raise the costs by P1.20 per the costs by P0.90 per case
case Modifications would cost
Modification would cost P20,000
P15,000
Machine 1- Semi Machine 2- Automated
Automated
[(Production capacity estimated downtime) x 250 [(Production capacity estimated downtime) x 250
Capacity days] days]
[(640 units - (12.5%) 640 units) x 250 days ] [(800 units - (25%) 640 units) x 250 days ]
= 140,000 units per year = 150,000 units per year
Total cost Material and variable overhead + machine cost Material and variable overhead + machine cost
per case
(no P 1.50 + P 2.50 = P 4.00 per case P 1.50 + P 1.75 = P 3.25 per case
overtime)
Total cost Material and variable overhead + machine cost + Material and variable overhead + machine cost +
(with overtime premiums overtime premiums
overtime) P 1.50 + P 2.50 + P 1.20 = P 5.20 per case P 1.50 + P 1.75 + P 0.90 = P 4.15 per case
Sales Volume Profit Sales Volume Profit
120,000 units (P 6 P 4) (120,000 units) 120,000 units (P 6 P 3.25) (120,000 units)
= P 240,000 = P 330,000
130,000 units (P 6 P 4) (130,000 units) 130,000 units (P 6 P 3.25) (130,000 units)
= P 260,000 = P 357,500
140,000 units (P 6 P 4) (140,000 units) 140,000 units (P 6 P 3.25) (140,000 units)
(capacity) = P 280,000 = P 385,000
150,000 units P 280,000 + ( P 6 P 5.20) 150,000 units (P 6 P 3.25) (150,000 units)
(overtime) (10,000 units) = P 288,000 (capacity) = P 412,500
150,000 units (P 6 P 4) (150,000 units) 160,000 units P 412,500 + ( P 6 P 4.15)
(modify) P 15,000 = P 285,000 (overtime) (P 10,000) = P 431,000
160,000 units P 280,000 + ( P 6 P 5.20) 160,000 units (P 6 P 3.25) (160,000 units)
(overtime) (20,000 units) = P 296,000 (modify) P 20,000 = P 420,000
160,000 units (P 6 P 4) (160,000 units)
(modify) P 15,000 = P 350,000
1. Which machine should Kay Tibay select?

Machine 2, because its total cost is lesser than machine 1 which earns more profit

2. Should overtime be scheduled?

Yes, because overtime incur more cost that would lessen the profit.

3. Should a machine be modified and if so, under what circumstances?

Yes, when sales volume is greater than its production capacity.