Question

McVay Industries (MI) produces ice cream supplies including bowls, scoops and shake makers. MI made $605,000 of pre-tax profit last year.  They are looking for ways to improve profitability and are considering outsourcing production of their shake makers. Juan Hernandez, the controller, compiled the following information.

	Bowls		Scoops		Shake Makers		TOTAL
Units Manufactured and sold	2,000,000		500,000		100,000
DM per unit	$0.50		$1.25		$5.00
DL per unit	$0.10		$0.50		$4.00
VMOH per unit	$0.15		$0.25		$5.00
FMOH per unit (based on current production)	$0.40		$0.50		$5.00
Total Cost per unit	$1.15		$2.50		$19.00
Selling Price	$2.00		$4.00		$25.00
Gross Profit per Unit	$0.85		$1.50		$6.00
Total Sales	$4,000,000		$2,000,000		$2,500,000		$8,500,000
Total COGS	$2,300,000		$1,250,000		$1,900,000		$5,450,000
Total Gross Profit	$1,700,000		$750,000		$600,000		$3,050,000
Total Variable (selling) costs	($300,000)		($100,000)		($125,000)		($525,000)
SG&A Fixed Costs – Direct*	($400,000)		($200,000)		($100,000)		($700,000)
SG&A Fixed Costs – Common**	($680,000)		($300,000)		($240,000)		($1,220,000)
Pre-Tax Profit	$320,000		$150,000		$135,000		$605,000

*   Direct SG&A Fixed Costs can be eliminated if the specific product is outsourced.

** Common  SG&A Fixed Costs can not be eliminated even if the specific product is outsourced.

If the shake maker is outsourced, fixed manufacturing overhead costs of $100,000 to lease machinery related to shake maker production could be eliminated.  Assume that direct fixed SG&A expenses relate directly to the shake makers line and could be completely eliminated if the shake maker product line is dropped.

Additionally, if the shake maker is outsourced, the company would have idle capacity and could produce and sell an additional 150,000 bowls (for the same selling price of $2 per bowl).  

Question: What is the maximum amount MI should pay for the shake maker from an independent supplier (price per unit) to be no worse off financially? Show your work please.

Answer 1

As per the data given in the question if the shake maker is dropped, then the profit from $605,000 drops to $230,000 since the common SG&A Fixed costs can not be eliminated if the shake makers is dropped even.

	Bowls	Scoops	Shake Makers	Total
Units Manufactured and sold	2,000,000	500,000	-
DM per unit	$                   0.50	$                   1.25	$                   0.50
DL per unit	$                   0.10	$                   0.50	$                   0.10
VMOH per unit	$                   0.15	$                   0.25	$                   0.15
FMOH per unit (based on current production)	$                   0.40	$                   0.50	$                   0.40
Total Cost per unit	$                   1.15	$                   2.50	$                   1.15
Selling Price	$                   2.00	$                   4.00	$                   2.00
Gross Profit per Unit	$                   0.85	$                   1.50	$                   0.85
Total Sales	$ 4,000,000.00	$ 2,000,000.00	$                       -	$    6,000,000.00
Total COGS	$ 2,300,000.00	$ 1,250,000.00	$                       -	$    3,550,000.00
Total Gross Profit	$ 1,700,000.00	$      750,000.00	$                       -	$    2,450,000.00
Total Variable (selling) Costs	$   (300,000.00)	$   (100,000.00)	$                       -	$     (400,000.00)
SG&A Fixed Costs - Direct	$   (400,000.00)	$   (200,000.00)	$                       -	$     (600,000.00)
SG&A Fixed Costs - Common	$   (680,000.00)	$   (300,000.00)	$   (240,000.00)	$ (1,220,000.00)
Pre Tax Profit	$      320,000.00	$      150,000.00	$   (240,000.00)	$       230,000.00

If the shake maker is dropped and in idle capacity of shake maker, an additional bowls to be made then also the profit of the company comes to $335,000.

	Bowls	Scoops	Additional Bowls	Total
Units Manufactured and sold	2,000,000	500,000	150,000
DM per unit	$                   0.50	$                   1.25	$                   0.50
DL per unit	$                   0.10	$                   0.50	$                   0.10
VMOH per unit	$                   0.15	$                   0.25	$                   0.15
FMOH per unit (based on current production)	$                   0.40	$                   0.50	$                   0.40
Total Cost per unit	$                   1.15	$                   2.50	$                   1.15
Selling Price	$                   2.00	$                   4.00	$                   2.00
Gross Profit per Unit	$                   0.85	$                   1.50	$                   0.85
Total Sales	$ 4,000,000.00	$ 2,000,000.00	$      300,000.00	$    6,300,000.00
Total COGS	$ 2,300,000.00	$ 1,250,000.00	$      172,500.00	$    3,722,500.00
Total Gross Profit	$ 1,700,000.00	$      750,000.00	$      127,500.00	$    2,577,500.00
Total Variable (selling) Costs	$   (300,000.00)	$   (100,000.00)	$      (22,500.00)	$     (422,500.00)
SG&A Fixed Costs - Direct	$   (400,000.00)	$   (200,000.00)	$                       -	$     (600,000.00)
SG&A Fixed Costs - Common	$   (680,000.00)	$   (300,000.00)	$   (240,000.00)	$ (1,220,000.00)
Pre Tax Profit	$      320,000.00	$      150,000.00	$   (135,000.00)	$       335,000.00

So if the company wants to maintain the same level of profit $605,000 and also wants to outsource the shake business then also company has to make sure they could even earn the same profit of $135,000 which they were earning from shake business.

In order to earn $135,000 from the additional bowls from idle capacity then they must sell the additional bowl at $3.80 per unit so that they can cover the fixed costs as well.