In: Accounting
8-28 Outsourcing and capacity utilization (LO 3, 4) | ||||||||||
PlayTime, Inc., is a leading manufacturer of sporting equipment. The company is in the process of evaluating the best use of its Plastics Division, which is currently manufacturing molded fishing tackle boxes. The company manufactures and sells 8,000 tackle boxes annually, making full use of its available capacity. The selling prices and costs of the tackle boxes are as follows: | ||||||||||
Selling price per box | $86.00 | |||||||||
Costs per box | ||||||||||
Direct materials | $17.00 | |||||||||
Direct labor | 18.75 | |||||||||
V ariable manufacturing overhead | 7.00 | |||||||||
Fixed manufacturing overhead | 6.25 | |||||||||
Variable selling & administrative | 10.00 | |||||||||
Fixed selling & administrative | 7.00 | |||||||||
Total cost per box | 66.00 | |||||||||
Profit per box | 20.00 | |||||||||
Managers believe they could sell 12,000 tackle boxes if the company had sufficient manufacturing | ||||||||||
capacity. Rod-N-Reel has offered to supply 9,000 tackle boxes per year at a price of $68 per box, including | ||||||||||
delivery to PlayTime's facility. Cedric Smith, Playtime's proudct manager, believes the company could | ||||||||||
make better use of its plastics department by manufacturing skateboards. A marketing report indicates | ||||||||||
that 17,500 skateboards could be sold at a price of $45 each. Variable costs to make the boards would be | ||||||||||
$22.50 per board. | ||||||||||
Playtime has three options: | ||||||||||
1. Make and sell 8,000 tackle boxes | ||||||||||
2. Make 8,000 tackle boxes, buy 4,000 additional tackle boxes, and sell 12,000 tackle boxes. | ||||||||||
3. make and sell 17,500 skateboards, and buy and sell 9,000 tackle boxes. | ||||||||||
Required | ||||||||||
Compare the company's operating income under the three options. |
We have fixed manufacturing cost of 6.25 per unit for 8000 units i.e = 8000 x 6.25, = 50000
Fixed selling expenses 7 x 8000=
in any case fixed expenses will remain to 106000 ( 50000+56000) ,
if company buys additional boxes , purchase cost per box = 68
selling price =86
Contribution on purchased boxes = 86 - 68, = 18
If company manufacture skate boards
Seeling price = 45
variable cost of manufavcturing skate board = 22.50
Contribution = 45-22.50, =22.50
Evaluating Three options we conclude as follows
1. Operating income = 8000 units x 20 profit per unit ,= $160,000
2. Selling 8000 manufactured and 4000 purchased boxes
Profit on 8000 boxes =160000 (same as in case 1)
contribution earned on 4000 purchased unit = 4000 x 18, =72000
Operating income = 160000+72000 = $232,000
Fixed cost has aready been recovered while selling 8000 manufactured units, we need not deduct again from purchased units
3. Contribution on skate boards sold = 17500 x 22.50, = 393750
contribution on purchased boxes = 9000 x 18, = 162000
Total contribution = 555750
less Fixed expenses (Total) 106000
Operating income = 555750-106000, = $449,750
hence company should go for case 3 as it gives maximum profit