Falco Scooters (A)
Written by Professor Igor Vaysman
1
The Falco Group is a holding company with majority ownership of numerous business-to-business and
usiness-to-consumer firms. The company’s flagship consumer holding is the wholly-owned Falco
Scooter Company. It cu
ently offers two models: the City-100 and the Super-300.
The City-100 model has a maximum speed of 50 mph; consequently, it is not allowed on most
expressways. The higher-end Super-300 uses a larger engine and enhanced safety systems; with its
maximum speed of 79 mph, it is approved for expressway riding in many areas.
The market for the City-100 is highly competitive – many competitors offer essentially identical scooters;
the cu
ent prevailing market price is $660. At this price, Falco can sell any number of City-100’s (our
cu
ent annual estimate is 5,000 – 6,000 unit sales).
The market for the Super-300 model is an oligopoly; Falco expects to sell 1,000 Super-300’s per year at
the cu
ent price of $3,000.
Falco Scooters has a single state-of-the-art assembly facility, where both scooter models are assembled
from parts purchased from a few well-chosen suppliers. One of the key strategies of the Falco Group is
to strive to maximize capacity utilization. Consequently, the scooter manufacturing facility operates at
its maximum practical capacity; the capacity constraint is equipment, measured in machine hours (MHs).
The two models are assembled using the same employees and equipment.
The key difference between the two scooter models is Super-300’s more-powerful engine. Cu
ently, the
engine is purchased from an outside supplier for $300 per unit.
As part of its long-term growth strategy in the business-to-business segment, the Falco Group recently
acquired all of the equity of Scorpion Motors – a small manufacturer of motorcycle engines. Scorpion
Motors makes and sells two engine models: Standard and Deluxe.
This particular acquisition was made in part because Scorpion Motors recently downsized, and cu
ently
the company’s single engine-manufacturing plant operates at its maximum capacity; the capacity
constraint at the engine plant is skilled labor, measured in direct-labor hours (DLHs). The same
employees manufacture both engine models using the same equipment.
The market for the Standard engine is highly competitive; at the prevailing market price of $75, Scorpion
Motors can sell any number of Standard engines (our cu
ent annual estimate is 20,000 – 25,000 annual
unit sales).
The Deluxe engine is made for a single external customer, MG Motorcycles, under a long-term contract
equiring Scorpion to deliver 2,500 Deluxe engines per year. The Deluxe uses a design developed and
patented by MG Motorcycles; Scorpion Motors is not allowed to sell this engine to any other client.
A recent review of potential internal synergies revealed that a modified version of the Deluxe engine
made at the Scorpion Motors Division could be successfully used by Falco Scooters for the Super-300,
instead of the engine cu
ently purchased. MG Motorcycles agreed to allow Scorpion to make this
modified Deluxe for Falco Scooters for a licensing fee of $30,000 per year. Modifications to make the
Deluxe fit on the Super-300 will require additional direct-materials (DM) costs at Scorpion Motors of
$30 for each Modified Deluxe. Neither costs nor volumes of the Deluxe units made for MG Motorcycles
will be affected.
Some additional information, collected from the two divisions’ normal-absorption reporting systems, is
elow:
2
Selling price $660 $3,000
Direct Materials (includes engine) $420 $1,260
Machine Hours 1 4
Direct Labor 5 DLHs @ $30 per DLH 20 DLHs @ $30 per DLH
Variable Overhead Allocation $6 per DLH $6 per DLH
Fixed Overhead Allocation $9 per DLH $9 per DLH
Falco Scooter Company, per-unit information
City-100 Super-300
Selling price $75 $300
Direct Materials $15 $120
Machine Hours 1 3
Direct Labor 1 DLH @ $30 per DLH 2 DLHs @ $30 per DLH
Variable Overhead Allocation $15 per DLH $15 per DLH
Fixed Overhead Allocation $3 per DLH $3 per DLH
Scorpion Motors, per-unit information
Standard Deluxe
NOTE: Falco Group managers believe that variable overhead at each division is really driven by direct
labor hours.
Required. In answering these questions, ignore taxes and opportunity-cost-of-capital
issues. Recall that both Falco Scooter Company and Scorpion Motors are wholly-owned
subsidiaries of the Falco Group.
1. Falco Scooters expects to sell 1,000 Super-300’s annually. From the point of view of the
Falco Group, should the engines for Super-300’s be purchased from the external supplier?
Or should the engines be made internally, by Scorpion Motors? Estimate the financial impact
on Falco Group from the switch to in-sourcing the engines.
2. Falco Scooters’ marketing department estimates that if the selling price on Super-300’s is
lowered to $2,925 per unit, annual sales of this model will increase to 1,350 units. Should
the company lower the price? How should they obtain the engine (make at Scorpion Motors
or buy from outside supplier) under this alternative pricing strategy? Provide full financial
analysis of the various alternatives.