Question

Cane Company manufactures two products called Alpha and Beta that sell for $185 and $120, respectively. Each product uses only one type of raw material that costs $5 per pound. The company has the capacity to annually produce 112,000 units of each product. Its average cost per unit for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	30			$	10
Direct labor			22				29
Variable manufacturing overhead			20				13
Traceable fixed manufacturing overhead			24				26
Variable selling expenses			20				16
Common fixed expenses			23				18
Total cost per unit		$	139			$	112

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars.

1. Assume that Cane normally produces and sells 48,000 Betas per year. What is the financial advantage (disadvantage) of discontinuing the Beta product line?

2. Assume that Cane normally produces and sells 68,000 Betas and 88,000 Alphas per year. If Cane discontinues the Beta product line, its sales representatives could increase sales of Alpha by 12,000 units. What is the financial advantage (disadvantage) of discontinuing the Beta product line?

3. Assume that Cane expects to produce and sell 88,000 Alphas during the current year. A supplier has offered to manufacture and deliver 88,000 Alphas to Cane for a price of $112 per unit. What is the financial advantage (disadvantage) of buying 88,000 units from the supplier instead of making those units?

4. Assume that Cane expects to produce and sell 58,000 Alphas during the current year. A supplier has offered to manufacture and deliver 58,000 Alphas to Cane for a price of $112 per unit. What is the financial advantage (disadvantage) of buying 58,000 units from the supplier instead of making those units?

Answer 1

1)			Beta
			48000 units per year
	Sale Price	48000*120	5760000
	Direct Materials	48000*10	-480000
	Direct Labour	48000*29	-1392000
	Variable Manufacturing overhead	48000*13	-624000
	Variable selling expenses	48000*16	-768000
	Traceable Fixed manufacturing overhead	112000*26	-2912000
	Common fixed expenses	112000*18	-2016000
	Profit/(Loss) from sale		-2432000
	If the product is sold it would lead to Loss of Rs -2432000
	If the product is discountinued there would be expense of Rs 2016000 which is common fixed expenses which is unavoidable
2)	If Beta Product is discountinued, the profit would be as follows
			Alpa
			(88000+12000) = 100000 units
	Sale Price	100000*185	18500000
	Direct Materials	100000*30	-3000000
	Direct Labour	100000*22	-2200000
	Variable Manufacturing overhead	100000*20	-2000000
	Variable selling expenses	100000*20	-2000000
	Traceable Fixed manufacturing overhead	112000*24	-2688000
	Common fixed expenses	112000*23	-2576000
	Common fixed expenses	112000*18	-2016000
	Profit/(Loss) from sale		2020000
	If beta product is continued the profit would be
		Alpha	Beta
		88000	68000
	Sale Price	16280000	8160000
	Direct Materials	-2640000	-680000
	Direct Labour	-1936000	-1972000
	Variable Manufacturing overhead	-1760000	-884000
	Variable selling expenses	-1760000	-1088000
	Traceable Fixed manufacturing overhead	-2688000	-2912000
	Common fixed expenses	-2576000	-2016000
		3008000	-1324000
	The overall profit would be $1684000 which is lower than the profit if Beta is discountinued
	The advantage would be (2020000-1684000)	336000
3	If 88000 units are produced the profit is $3008000
	If 88000 units are bought for a price of $112 per unit
	Sales	16280000
	Less : Cost (88000*112)	-9856000
	Less: Common fixed expenses(unavoidable)	-4592000
		1832000
	There would be financial disadvantage of (3008000-1832000)	1176000
4)	If 58000 units are bought for a price of $112 per unit
	Sales	10730000
	Less : Cost (58000*112)	-6496000
	Less: Common fixed expenses	-4592000
		-358000
		Alpha
		58000
	Sale Price	10730000
	Direct Materials	-1740000
	Direct Labour	-1276000
	Variable Manufacturing overhead	-1160000
	Variable selling expenses	-1160000
	Traceable Fixed manufacturing overhead	-2688000
	Common fixed expenses	-4592000
		-1886000
	If purchase the loss would be -358000 else it would be -1886000
	The answer to 3 and 4 is based on the assumption that the common fixed expenses would still be continued