Question

Drake Ltd makes three products for industrial use, with the following details per unit: RG40 RG50 RG60 £ £ £ Selling price 110 140 100 Direct labour (£12 per hour) 30 24 36 Direct material A (£5 per litre) 10 5 0 Direct material B (£8 per kilo) 16 0 32 Variable overhead: Labour related 3 2.4 3.6 Machine related 5 7 3 Component XG 50 Total variable cost 64 88.4 74.6
Machine hours per unit 5 7 3 Maximum demand per week 800 3,000 2,400 Component XG, used in product RG50, is currently purchased from an outside supplier but could be made internally using the following resources; Direct labour: 1 hour Direct material B: 2 kgs. Machine time: 0.5 hour In addition to the demand shown above Drake Ltd has signed a contract with a new customer Brook Ltd to provide the following units each week for the next six weeks: Product units RG40 200 RG50 200 RG60 300 The machine hours available each week are 37,500 hours. The purchasing manager has been informed by suppliers that for the next six weeks the availability of Material B will be restricted to 12,000 kg Required: a) Alison Drake, The Director of Drake Ltd is not an accountant. She wishes to know the most profitable weekly use of the restricted machine hours and material B resources during each week of the next six weeks, including whether to produce component XG or continue to outsource it. (Linear programming is not required). She also wants to know the impact on profits of Drake Ltd if the new contract with Brook Ltd could be deferred for six weeks. Prepare statements to calculate the above information. b) Using your workings, describe clearly to Alison Drake how the information provided by each of the statements you have prepared is used to calculate how she should proceed during the six weeks and give your recommendations.   

Answer 1

Recommendation:

a) It would be beneficial to proceed with manufacturing -inhouse of Component XG instead of outsourcing as there is a cost saving of 43% (50) - (28) [12+16+0.5] = 21.50

b) Drake Ltd can accept the offer of Brook ltd, as the profitability considering restricted Material B and Machine hours as well as the inhouse manufacturing of Component XG,  the total profitabiliy increased by 29%

Hence Drake Ltd should consider the proposal and inhouse manufacturing component XG

Working Notes:

Existing Profitability per unit: (without considering Inhouse cost Component XG)

Particulars	RG40	RG50	RG60
Selling Price	110	140	100
Less:
Direct Labor	30	24	36
Direct Material A	10	5	0
Direct Material B	16	0	32
Component XG		50
Variable Overheads:
Labor	3	2.4	3.6
Machine	5	7	3
Total Cost	64	88.4	74.6
Profit	46	51.6	25.4

Revised Statement of Cost: Considering Inhouse manafacturing of Component X

Particulars	RG40	RG50	RG60
Selling Price	110	140	100
Less:
Direct Labor	30	24	36
Direct Material A	10	5	0
Direct Material B	16	0	32
Component XG		28.5
Variable Overheads:
Labor	3	2.4	3.6
Machine	5	7	3
Total Cost	64	66.9	74.6
Profit	46	73.1	25.4

Available Machine hours - restricted - 37,500 per week

RG40 - 12500

RG50 - 17500

RG60 - 7500

Total - 37500

With existing demand per week RG40 - 800, RG50 - 3000, RG60- 2400, the total machine hours require is 32200

RG40 - 4000

RG50 - 21000

RG60 - 7200

Total - 32200

Even the machine hours restricted, it is good to proceed to accept the proposal.

Statement of Profitability - revised - Considering Restricted 12000 kgs and In house Component XG

Particulars	RG40	RG50	RG60	Total
	200	200	300
Selling Price	22000	28000	30000	80000
Less: Cost	12800	13380	22380	48560
Profit	9200	14620	7620	31440

Statement of Profitability - Existing:

Particulars	RG40	RG50	RG60	Total
	200	200	300
Selling Price	22000	28000	30000	80000
Cost	12800	17680	22380	52860
Profit	9200	10320	7620	27140