Question

Banana Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However, Banana’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.

The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $13 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $96,000 charge for fixed manufacturing overhead will be absorbed by the product under the company’s absorption costing system.

Using the estimated sales and production of 120,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:

Direct material	$	5.40
Direct labor		3.80
Manufacturing overhead		2.30
Total cost	$	11.50

The costs above relate to making both the lip balm and the tube that contains it. As an alternative to making the tubes for Chap-Off, Banana has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $2.30 per box of 24 tubes. If Banana Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 30%.

Required:

1. If Banana buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able to avoid? (Hint: You need to separate the manufacturing overhead of $2.30 per box that is shown above into its variable and fixed components to derive the correct answer.)

2. What is the financial advantage (disadvantage) per box of Chap-Off if Banana buys its tubes from the outside supplier?

3. What is the financial advantage (disadvantage) in total (not per box) if Banana buys 120,000 boxes of tubes from the outside supplier?

4. Should Banana Industries make or buy the tubes?

Answer 1

Solution 1:

Total manufacturing overhead per unit at 120000 boxes = $2.30 per unit

Fixed manufacturing overhead per unit = $96,000 / 120000 = $0.80 per unit

Variable manufacturing overhead per unit = $2.30 - $0.80 = $1.50 per unit

Reduction in Chap-Off manufacturing costs per box, if tubes purchased from outside vendor = (Direct labor cost per unit + Variable manufacturing overhead per unit) * 10% + Direct material cost per unit * 25%

= ($3.80 + $1.50)*10% + ($5.40*30%) = $2.15 per unit

Solution 2:

financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier = $2.15 - $2.30 = ($0.15)

Solution 3:

Financial advantage (disadvantage) in total (not per box) if Silven buys 115,000 boxes of tubes from the outside supplier = -$0.15 * 120000 = ($18,000)

Solution 4:

As there is net financial disadvantage of $18,000, therefore silven should make the tubes.