Background

Problem Statement

At what prices should Lipman Bottle Company service its customers?

Analysis

One of the conditions set by Mr. Lipman in coming up with the prices is that the total income before tax
should equal 30% of sales revenue while working at capacity. The company’s capacity could service up
to $1,000,000 in sales revenue per year. The fixed costs for 10 months is known to be $106,944,
resulting in fixed costs of $106,944 ÷ 10 months = $10,694.4 per month or $10,694.4 per month x 12
months per year = $128,332.80 per year. The target operating income is 30% of $1,000,000 or $300,000
at capacity. Given these information we could use the formula for operating income to isolate the
required total variable costs to achieve the condition by Mr. Lipman.

Sales Revenue – Total Variable Costs – Total Fixed Costs = Operating Income

Total Variable Costs = Sales Revenue- Total Fixed Costs -Operating Income

Total Variable Costs = $1,000,000 - $128,332.80 - $300,000

Total Variable Costs = $571,667

The company should incur total variable costs of $571,667 to reach its target operating income. This
value could be divided by the variable cost per order to get the number of orders required. Afterwards,
we divide Sales Revenue of $1,000,000 at capacity by the number of orders required to get the selling
price per order.

The next problem would be determining the variable costs per order. The costs per order can be
classified into three: variable costs based on machine hours, variable costs based on number of passes,
and fixed costs. The variable costs based on machine hours and number of passes is already computed
at $14.63 per MH and $2.63 per thousand passes, respectively. The orders can be classified based on
bottle size (0-1oz, 1.25-4 oz, 5-6 oz, 7-10, oz, 11-12 oz, 13-16 oz, and 17-32 oz), order quantity range
(5000-9999, 10000-24999, 25000-49999, 50000-999999, 100000-249999, and 250000+), location
(Albany and New York-New Jersey), and bottle-processing type (One-Separation Rounds, Two-
Separation Rounds, and Two-Separation Ovals). These result in 7x6x2x3 = 252 different order types each
with a unique variable cost (in this case, we will be determining cost per thousand bottles). The
differences among the classifications are summarized as follows:

 The classifications based on bottle sizes differ in their operating time (machine hours) due to the
added difficulty for operating the machine with relatively small (0-1 oz) and large (17-32 oz)
bottles.
  The classifications based on order quantity differ in the allocated set-up time per thousand
bottles. The higher the order quantity, the lower set-up time per thousand bottles. Set-up time
costs are approximately equal to operating costs.
 The classifications based on location differ in their scrap and shipping costs. The printing
operations in Albany are done on bottles manufactured by the Lipman Bottle Company itself
which results in scrap costs. The printing operations planned for New York-New Jersey will be
done on bottles provided by the customer so scrap costs will not be incurred. However, shipping
costs to transfer the bottles to New York-New Jersey will be incurred.
 The classifications based on bottle-processing type differ in the number of passes required to
accomplish the job. More passes will require more machine hours.

To illustrate the variable costs per 1000 bottles associated with a specific order, we will take the
example of an order quantity of 5000-9999, 0-1 oz round bottles in Albany using one separation.

Order Quantity 5000-9999

Mean Size 7500
Set-up time (hrs)1 2.00
Set-up time (hours per
thousand) [2/7.5] 0.27
Operating Time1 1.00
Total Hours 1.27
Cost per hour($)2 14.63
Total Cost based on hours
($)[14.63x1.27] 18.53
No. of passes (in thousands) 1.00
Cost per thousand passes ($) 2.63
Total Cost based on passes
[1.00x2.63] 2.63
Scrap Costs ($)3 1.40
Shipping Costs ($) 0.00
Total Costs per thousand bottles
($) [18.53+2.63+1.40] 22.56

The computation of total variable costs per thousand bottles is performed on each classification (Refer
to Exhibit X for the variable costs per classification). Now that we have computed the variable cost per
order classification, we use the $571,667 total variable costs to fulfil Mr. Lipman’s condition and divide it
by the total variable costs per order to get the number of orders required. We then divide $1,000,000 by

1
Taken from Exhibit 4: Operating Information

2
Taken from Exhibit 1
3
Taken from Exhibit 3: Scrap and Shipping Costs
this number to get the selling prices. An illustration of this computation based on an order quantity of
5000-9999, 0-1 oz round bottles in Albany using one separation is detailed below.

Total Variable Costs ÷ Variable Costs per Order = Number of Orders [Equation 1]

$1,000,000 (Sales Revenue at Capacity) ÷ Number of Orders = Estimated Selling Price per Order
[Equation 2]

$571,667 ÷ $22.56/order = 25,339.80 orders (using Equation 1)

$1,000,000 ÷ 25,339.80 orders = $39.46 per order (using Equation 2)

Applying this calculation to all classification yields Exhibit Y. However, the price list in Exhibit y is not
adjusted for competition.