Question: “Ferguson Metals”

Ferguson metals is a decentralized mining smelting and metals company with three divisions: mining lead and copper. The mining division owns the ore mine that produces the lead and copper that occur in the vein. Mining removes the ore crushes it and smelts it to separate the metals from the crushed rock. It then sells the two products to the other two divisions: lead and copper. Each batch mined yields 50 tons of lead and 25 tons of copper (one ton is 2000lbs) The metal are transferred from mining to the lead and copper divisions at cost plus a small profit to give mining an incentive to produce.

TABLE 1 MINING DIVISION INCOME TATEMENT PER BATCH

REVENUE $42,000 $21,000

COSTS*

MINING 22,000 11,000

PROFITS PER BATCH $4000 $2000

*based on normal volume of 100 batches per year

LEAD COPPER

SALES $6600 $6700

VARIABLE COSTS

METAL COSTS* 5000 2200

OTHER COSTS 500 700

CONTRIBUTION MARGIN $1100 $3800

FIXED COSTS 800 1100

NET INCOME BEFORE TAXES $300 $2700

NET INVESTMENTS $10,000 $14,000

*the metal costs exceed the costs of the mining division because some metals are purchased on the open market to expand capacity and to smooth production of the downstream industrial products.

The current market price for copper is roughly $.60 per pound; for lead it is $.30 per pound. But these prices are for substantially purer copper and lead than the mining division has the ability to produce. Mining could sell its lead in the market at its current purity level for $.17 per pound. Since the metal divisions are currently incurring the cost to refine the metals to the purity levels they require, management does not believe it is equitable to charge the divisions the current market prices for the unrefined metals. If the metals were transferred at market prices. The lead and copper divisions would be paying twice for the refining process and the mining division would be rewarded for a level of purity it is not providing.

Table 1 shows the mining divisions income statement per batch.

The variable mining and smelting costs per ton of lead and copper are based on the fixed yields of the two metals. Production last year at mining was 100 batches and both the lead and copper divisions had no change in inventory levels.

The lead and copper divisions further process the two metals into industrial products. Because of increasing foreign competitions the lead division has been showing a negligible return on investment. Table 2 shows income statements for the two metal divisions for last year.

All of the fixed costs in both the lead and copper divisions represent separable annual cash outflows to maintain current capacity. They are not common costs. Fergusons top management has the opportunity to invest in what appears to be a highly profitable joint mining venture which promises very high returns. Fergusons share of the net present value of the venture is around $30 million, discounted at the firms before tax cost of capital of 12%. To finance this project the company is considering divestiture of the lead divisions. A foreign company looking to gain investment in the division is $10 million management reasons it can use the proceeds to undertake the joint venture.

Should management sell the lead division to the foreign company Present an analysis supporting your conclusions?