SHERMAN MOTOR COMPANT CASE ANALYSIS

BACKGROUND:
Sherman Motor Company manufactures two specialised models of truck in a single plant. It
consists of four manufacturing operations: metal stamping, engine assembly, model 101
assembly and model 102 assembly. Out of the four departments Metal Stamping was
operating at 56.2% of capacity and model 101 assembly was operating at only 14.8%.
The sales manager suggested to stop production of model 101 trucks to improve profitability.
However, the production manager suggests against dropping model 101 trucks. He believes
that increasing production of model 101 trucks and cutting back on model 102 trucks will
improve profitability.
PROBLEM:
The fundamental problem faced by Sherman motor company was to find an optimized
production for both the models so as to maximize the profits because of the high fixed
overhead costs.
ANALYSIS:
From the case we know that not all the manufacturing departments at SMC were working at
their full capacity. To determine the optimal product mix, so that all the resources are
efficiently used to reduce the costs, we formulate a linear programming model which was
solved using excel solver to obtain the results. The main goal is to increase profits so profit
maximization becomes the objective function for the LP model. We know Profit = Revenue
Cost. The selling price for model 101 is $2100 and for model 102 is $2000. The variable cost
associated with each model is shown in the table below along with the overall fixed overhead
cost.

MODEL
101

102

Variable overhead
Direct Materials
Direct Labour
Total Variable Cost
Fixed Cost

400
1200
200
1800

425
1000
225
1650
385000

Table 1 COST ANALYSIS

So, the objective function can be written in mathematical terms as

Pmax = (2100-1800)*Q101 + (2000-1650)*Q102 -385000 ----------------------------------------- (1)
We also have five constraints
Metal Stamping

7Q101 + 5Q102 = 17500

-------------------------------------------- (2)

Engine assembly

Q101 + 1.99Q102 = 3333

-------------------------------------------- (3)

Model 101 assembly

Q101 2250

--------------------------------------------- (4)

Model 102 assembly

Q101 1500

-----------------------------------------------(5)

Also Q101 & Q102 0 and integers.

Then we use excel solver to determine the optimal solution

Table 2 OPTIMIZED MODEL

Based on Table 2 we can see that in the optimised model if SMC produces 2037 units of
model 101 trucks and 648 units of model 102 trucks, then it can maximise its profits and use
the make efficient use of the capacity available in facility. From this we can also support the
Production manager claims that producing model 101 more will increase profits, which is

about $469,174. The pro-forma profit/loss statement for the optimised model is shown in
Exhibit 2.
Now, if SMC management decides to outsource the engines, the constraints related to engine
assembly (eqn. 3) and the associated variable cost are ignored. We again use excel solver

Table 3 OPTIMISED MODEL WITH ENGINES OUTSOURCED

From the above Table 3 we can observe that SMC can produce 1429 units of model 101 and
1500 units of model 102 and makes a profit of $1,284,286.
The maximum labour and overhead charge that SMC can pay for the additional engines is the
difference between profits of Table 2 and Table 3.
Outsourcing charge for engines = $1,284,286 - $469,174 = $815,112
This means we if the outsourcing charges are less than $815,112 the SMC should outsource
its engine assembly and vice-versa.
To determine whether SMC should invest in additional engine capacity we use the sensitivity
analysis report from excel solver. The table below shows the sensitivity report of the
optimised model.

Table 4 SENSITIVITY ANALYSIS

INCOME STATEMENT
With Assumtions*
Net Sales
$ 5,573,700.00
C.O.G.S
$ 4,735,800.00
Contribution
$
837,900.00
SG & A*
$
695,457.00
NIBT
$
142,443.00
Tax*
$
75,494.79
Net Income
$
66,948.21

In order to generate more profits SMC

should produce more model 101 trucks, but

since there is a resource constraint it is advisable to invest in additional engine capacity as is

evident from Table 4. The shadow price represents the profit generated per unit increase in
capacity of the limiting constraint. It is clear from the table above that if SMC has enough
funds then it would be wise to invest in additional engine capacity as it generates the highest
profit among all the other departments. Also, investing in both metal stamping and engine
assembly is recommended as both them have some profits associated with per unit capacity
increase, whereas there is no point in investing in model 101 and 102 assembly as its shadow
price is zero i.e, no amount of capacity increase will have an effect on profits.
CONCLUSION:
To conclude, we recommend the SMC should increase the units produced of model 101
trucks and should not take the sales managers advice. Also, if the management decides to
outsource engine assembly in order to remove the capacity constraint, we recommend doing
so only if the cost of outsourcing is less than $815,112. If the cost is greater than this price
then do not outsource. We would also recommend investing in additional engine capacity to
maximise profits as is evident from Table 4 shadow price.

APPENDIX
EXHIBIT 1 : Pro-forma profit/loss statement for optimised model