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P $8-20$: Karsten Mills

Karsten Mills is one of the premier carpet manufacturers in the world. It manufactures carpeting

for both residential and commercial applications. Home sales and commercial sales each account

for about $50$ percent of total revenue. The firm is organized into three departments:

manufacturing, residential sales, and commercial sales. Manufacturing is a cost center and the

two sales departments are profit centers. The full cost of each roll of carpeting produced

$($including fully absorbed overhead$)$ is transferred to the sales department ordering the carpet.

The sales departments are evaluated as profit centers; the full cost of each roll is the transfer

price.

The current manufacturing plant is at capacity. A new plant is being built that will more than

double the capacity. Within two years, management believes that it can grow Karsten's businesses

such that most of the excess capacity will be eliminated. When the new plant comes on line, one

plant will produce exclusively commercial carpeting and the other will produce exclusively

residential carpeting. This change will simplify scheduling, ordering, and inventory control in

both plants and will create some economies of scale through longer mill runs. Nevertheless, it will

take a couple of years before these economies of scale can be realized.

Each mill produces carpeting in $12-$foot$-$wide rolls of up to $100$ yards in length. The output of

each mill is measured in yards produced. Overhead is assigned to carpet rolls using carpet yards

produced in the mill. The cost structure of each plant is as follows:Besides being able to run at higher speed, producing more carpet yardage per hour, the new mill will use $15$

percent less direct material and direct labor because the new, more automated machines produce less scrap

and require less direct labor per yard. The cost of a job run at the old mill isAlthough the new mill has lower direct costs of producing carpeting than the old mill, the higher overhead

costs per yard at the new mill have the sales department managers worried. They are already lobbying

senior management to have the old mill assigned to produce their products. The commercial sales

department manager argues, "More of my customers are located closer to the old plant than are residential

sales' customers. Therefore, to economize on transportation costs, my products should be produced in the

old plant." The residential sales department manager counters with the following argument:

"Transportation costs are less than $1$ percent of total revenues. The new plant should produce commercial

products because we expect new commercial products to use more synthetic materials and the latest

technology at the new mill is better able to adapt to the new synthetics." Senior management is worried

about how to deal with the two sales department managers' reluctance to have their products produced at

the new plant. One suggestion put forth is for each plant to produce about half of commercial sales $\frac{?}{\text{b}\text{a}\text{r}}($ Page $367)$

products and about half of residential sales products. But this proposal would eliminate most of the

economies of scale that would result from specializing production in each plant to one market segment.

Required:

a$.$ Calculate the overhead rates for the new plant and the old plant, where overhead is assigned to carpet based on normal

yards per year.

b$.$ Calculate the expected total cost of carpet A$6106$ if run at the old mill and if run at the new mill.

c$.$ Put forth two new solutions that would overcome the resistance of the residential and commercial sales department

managers to the new plant. Discuss the pros and cons of your two solutions.

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