Traffic Paint Currently, Welle

Traffic Paint

Currently, Wellesley has the traffic paint contracts for thestates of Pennsylvania, North Carolina,

Delaware, and Virginia. Of last year’s total production of380,000 gallons, 90% was traffic

paint. Of this amount, 88,000 gallons were for the Virginiacontract. Each state has unique specifications

for color, thickness, texture, drying time, and othercharacteristics of the paint. For example,

paint sold to Pennsylvania must withstand heavy use of salt onroads during the winter.

Paint for North Carolina highways must tolerate extended periodsof intense heat during summer

months.

The process of bidding on a traffic paint contract begins with aroad test under the supervision

of the National Association of Highway Paints (NAHP), anindependent organization supported

by state funds. NAHP designates a certain stretch of highway toserve as the road test site.

Any paint manufacturer may apply stripes of their paint at thetest site. NAHP monitors the test

site and reports the results to the state highway department.State personnel review the reports

and invite the manufacturers of the best-performing paints tosubmit bids. The firm that submits

the lowest bid wins the contract.

Contracts, which normally cover a five-year period, specify onlythe price per gallon and

quality requirements such as drying time and road-life. Thetiming of deliveries is determined

later based on state work schedules and weather constraints.Demand is highly seasonal, as states

do most of their highway painting in June, July, and August. Thetotal amount of paint a state will

order is not determined until spring, when the states know howmuch of their highway budget

remains after winter snow removal costs have been paid.

After the paint is produced, the state must test the paintbefore approving it for shipment. A

sample is sent to the state laboratory, which may take up to twomonths to perform the testing. In

the meantime, Wellesley must store all the manufactured paint inits warehouse. At times, the

warehouse has been filled to capacity, and drums of paint arestored in the aisles, production

areas, and any available inch of space.

Due to the high cost of shipping paint, most paint producers canbe competitive on price

only in locations fairly close to their production facilities.Accordingly, Wellesley has enjoyed an

advantage in bidding on contracts in the eastern states close toVirginia. However, one of their

biggest competitors, Heron Paint Company of Houston, Texas, isbuilding a new plant in North

Carolina. With lower costs due to their efficient new facilityand their proximity, Heron will become

a major competitive threat.

Commercial Paint

Wellesley’s commercial paint line includes interior and exteriorhouse paints in a wide range

of colors formulated to approximate authentic colonial colors.Because of the historical association,

the line has been well received in Virginia. Most of thesepaints are sold through paint and

hardware stores as the stores’ second or third line of paint.The large national firms such as Benjamin

Moore or Sherwin Williams provide extensive services to paintretailers such as computerized color matching equipment. Partlybecause they lack the resources to provide such amenities

and partly because they have always considered the commercialpaint a sideline, Wellesley has

never tried to market their commercial line aggressively.

Mrs. W. is worried about the future of the company. The firm’sstrategic goal is to provide a

quality product at the lowest possible cost and in a timelyfashion. After absorbing the shock of

losing the Virginia contract, Mrs. W. wondered whether the firmshould consider increasing production

of commercial paints to lessen the company’s dependence ontraffic paint contracts. Her

son, who manages the day-to-day operation of the firm, believesthey can double their sales of

commercial paint if they undertake a promotional campaignestimated to cost $15,000. The average

price of traffic paint sold last year was $9 per gallon. Forcommercial paint, the average price

was $11.

Cost Data

Charlie Oliver has assembled the following data to evaluate thefinancial performance of the

two lines of paint. The primary raw material used in paintproduction is latex. The list price for

latex is $13.50 per pound. If the firm uses more than 150,000pounds annually they qualify for a

10% discount; 450 pounds of latex are needed to produce 1,000gallons of traffic paint. Commercial

paint requires 325 pounds of latex per 1,000 gallons of paint.In addition to the cost of the

latex, other variable costs are as shown below.

Raw materials cost per gallon of paint: Traffic Commercial

Camelcarb (limestone) 0.38 0.54

Silica 0.37 0.52

Pigment 0.12 0.38

Other ingredients 0.06 0.03

Direct labor cost per gallon 0.46 0.85

Freight cost per gallon 0.78 0.43

Last year, overhead costs attributable to the traffic painttotaled $85,000, including an estimated

$25,000 of costs directly associated with the Virginia contract.Overhead costs attributable

to the commercial paint are $13,000. Other manufacturingoverhead costs total $110,000. Charlie

estimates that $9,000 of this amount is inventory handling coststhat will be avoided due to the

loss of the Virginia contract. Both the remaining manufacturingoverhead and the general and

administrative costs of $140,000 are allocated equally to allgallons of paint produced.

Question:. Calculate the contribution margin(selling price minus variable costs) and gross margin

(selling price minus all manufacturing costs) per gallon foreach type of paint and total firm-wide

profit under each of the following scenarios:

Scenario A Current production, including the Virginiacontract

Scenario B Without either the Virginia contract or the promotionto expand sales of commercial

paint

Scenario C Without the Virginia contract but assuming thepromotional campaign is undertaken

and sales of commercial paint do in fact double

What insight is provided by a comparison of Scenarios A and B?What insight is provided by

a comparison of Scenarios B and C?