Energy Gel: A New Product Introduction Case Study Analysis
Equipment-Based Costing
Frank Nansen: the Corporate Controller was known for the creation of argument between Wickler and Leiter. Instead of favoring one of them, he suggested different approach, which is Equipment-Based Costing. According to Frank Nanzen, equipment-based costing will the most accurate method for evaluating the energy gel project.
In equipment-based costing; the ROIC is 20% which is higher than the direct costing and full costing method. The payback period remains the same in this approach. The project will have an opportunity benefit of 0.8 million for 10 years. This project doesn’t need a huge amount of investment, only 3.5 million would be the project cost, which the company will obviously invest in direct costing. Only rental paymentswill be required in equipment-based costing, along with selling and administration cost. The project will use the idle capacity of the Quickpro bar, but the cost of production will also be included. The payback period for full costing is 9 years, which is same as full costing payback period.
Sensitivity Analysis
The Sensitivity analysis is conducted on all costing approach. We have assumed that the company has resistedfrom distributing dividends and has retained all the net earnings at the end.
The ROIC has been decreased to 55%, and the payback period is increased by4 years in the full costing approach. But still, the Equipment based costing is more preferable, because if we just look at the ROIC of full costing without any sensitivity analysis; the ROIC is 16% and the payback period is the 9th year. (see exhibit 7 and 8)
In the end, the equipment-based costing would still be a beneficial approach in comparison to the remaining proposals, because it will bear the rental cost and will have an opportunity cost of 0.8 million. It could be seen that the full costing and equipment-based costing are yielding same payback period, and the ROIC is higher in the Equipment based costing. While, the direct costing approach is not profitable, because it is not considering other important aspects, including the cannibalization impact on profit.
Recommendation
We recommend the introduction of energy gel by using Frank Nanzen’s proposed approach of equipment-based costing. It is the best approach to account for the energy gel product, using the idle capacity of Quickpro machinery. A low amount of investment is required. The company is financing its project through a loan, with an interest rate of 8.25%. The less amount of investment will allow the company to pay a less amount of interest as well.
Frank’s approach will justify the costing as well, because by indirect costing; Leiter’s Quickpro bar will bear 100% of the production cost, which is unfair. Even, he himself wasn’t in the favor of the full costing approach, because purchasing the new machinery is unfair when you already have the machinery with idle capacity.
In the end, Equipment-based costing is the middle point where both will agree, because it saves the interest of both the individuals, with not just less amount of investment,but also with a higher ROIC and the same payback period...................................
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