SEWMEX: Short-Term Profit Planning In An International Setting

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SEWMEX: Short-Term Profit Planning in an International Setting

INTRODUCTION

SEWMEX is a newly formed sewing factory located in Mexico. SEWMEX, owned by an American company, is incorporated in Mexico as a Mexican company, and is enrolled in the maquiladora program[1] in Mexico. By contract, the American parent company, SEW Inc. (henceforth referred to as SEW), purchases all of SEWMEX’s output. SEW provides all raw materials to SEWMEX. These transactions occur under the maquiladora system and North American Free Trade Agreement (NAFTA) rules so that no import or export duties are required on these transfers. Because of this, the maquiladora is responsible only for assembling the raw materials into finished products and then shipping the completed products back to SEW in the U.S. As a result, SEWMEX has no raw materials cost. However, to be able to meet rush orders without waiting for materials to be imported, SEWMEX does maintain a small inventory of finished product. In addition to SEWMEX, SEW has several other factories located in the southeastern part of the U.S. One of the factories (located in southeastern Mississippi) also serves as a distribution center and central warehouse where finished goods from all the other factories are stored and ultimately shipped. From this distribution center, SEW supplies customers in all 50 states and Canada. The controller of SEW recently resigned unexpectedly after a disagreement with the president of the company. After his departure, many of his calculations concerning SEWMEX mysteriously disappeared. Given the cost of labor in the U.S. factories, the president of SEW would like to send as much future production to SEWMEX as possible. However, the SEWMEX operation is relatively new and not yet profitable. Therefore, both SEW and SEWMEX could benefit from profit-planning exercises. As a start the president would like for you, in your capacity as assistant controller, to develop a cost-volume-profit (CVP) model for the SEWMEX facility, which model could be used to address a number of short-term profit-planning issues. In particular, the president would like to get a better handle on exactly what volume of output would be needed to make SEWMEX profitable in the short run (given the present mix of garments produced) and what strategies might be pursued longer term to improve operations and therefore profitability. The president also wonders how, if at all, the issue of foreign exchange rates might complicate the profit-planning process. Therefore, he has charged you with the responsibility of developing the CVP model for SEWMEX, while he looks for a new controller. As someone interested in making a positive impression on the president, you are eager to accept this assignment.
FACTS
When you were hired by SEW, the controller of the company explained that in the sewing industry it is normal to cost and price garments on the basis of what is called “Standard Allowed Minutes” (SAMs) associated with the production of each garment.[2] In fact, in the sewing industry production is often measured in these terms rather than in units of finished product. The controller had explained to you that SAMs are based on production engineers’ estimates of time needed to perform each sewing operation and therefore the total time required to complete a particular style garment. The estimates are derived from time-and-motion (i.e., industrial engineering) studies and take into account a number of variables, including the speed of each type of sewing machine required for a specific operation, the education/training of each operator, and existing technology used by the assembly workers at SEWMEX.
Budgeted Selling Prices In preparing you for this project, the president of SEW provided you with the per-unit selling price data presented in Table 1.[3] The prices listed in Table 1 are expressed in U.S. dollars (USD) and are based on SEW’s transfer price[4] determination for
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