Question

Cane Company manufactures two products called Alpha and Beta that sell for $190 and $155, respectively. Each product uses only one type of raw material that costs $8 per pound. The company has the capacity to annually produce 122,000 units of each product. Its average cost per unit for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	40			$	24
Direct labor			34				28
Variable manufacturing overhead			21				19
Traceable fixed manufacturing overhead			29				32
Variable selling expenses			26				22
Common fixed expenses			29				24
Total cost per unit		$	179			$	149

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.

a. Assume that Cane normally produces and sells 74,000 Betas and 94,000 Alphas per year. If Cane discontinues the Beta product line, its sales representatives could increase sales of Alpha by 14,000 units. What is the financial advantage (disadvantage) of discontinuing the Beta product line?

b. Assume that Cane expects to produce and sell 94,000 Alphas during the current year. A supplier has offered to manufacture and deliver 94,000 Alphas to Cane for a price of $136 per unit. What is the financial advantage (disadvantage) of buying 94,000 units from the supplier instead of making those units?

c. Assume that Cane expects to produce and sell 69,000 Alphas during the current year. A supplier has offered to manufacture and deliver 69,000 Alphas to Cane for a price of $136 per unit. What is the financial advantage (disadvantage) of buying 69,000 units from the supplier instead of making those units?

d. How many pounds of raw material are needed to make one unit of each of the two products?

Answer 1

Solution a:

Differential Analysis - Sale Alpha (94000 Units), Beta (74000 Units) (Alt 1) or Discontinue Beta & Sale Alpha (108000 Units) (Alt 2)
Particulars	Sale Alpha (94000 Units), Beta (74000 Units) (Alt 1)		Discontinue Beta & Sale Alpha (108000 Units) (Alt 2)		Differential effect on income (Alt 2)
	Details	Amount	Details	Amount
Revenue	(94000*$190) + (74000*$155)	$29,330,000.00	108000*$190	$20,520,000.00	-$8,810,000.00
Costs:
Direct Material	(94000*$40) + (74000*$24)	$5,536,000.00	108000*$40	$4,320,000.00	-$1,216,000.00
Direct Labor	(94000*$34) + (74000*$28)	$5,268,000.00	108000*$34	$3,672,000.00	-$1,596,000.00
Variable manufacturing Overhead	(94000*$21) + (74000*$19)	$3,380,000.00	108000*$21	$2,268,000.00	-$1,112,000.00
Variable Selling Expenses	(94000*$26) + (74000*$22)	$4,072,000.00	108000*$26	$2,808,000.00	-$1,264,000.00
Traceable Fixed manufacturing overhead	(122000*$29) + (122000*$32)	$7,442,000.00	122000*$29	$3,538,000.00	-$3,904,000.00
Common fixed expenses	(122000*$29) + (122000*$24)	$6,466,000.00	(122000*$29) + (122000*$24)	$6,466,000.00	$0.00
Income / (Loss)		-$2,834,000.00		-$2,552,000.00	$282,000.00

Solution b:

Differential Analysis- Cane Company - Making Alpha (alt 1) or Buying Alpha (Alt2)
Particulars	Making Alpha (Alt 1)	Buying Alpha (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (94000*$136)	$0.00	$12,784,000.00	-$12,784,000.00
Direct material	$3,760,000.00	$0.00	$3,760,000.00
Direct Labor	$3,196,000.00	$0.00	$3,196,000.00
Variable manufacturing overhead	$1,974,000.00	$0.00	$1,974,000.00
Avoidable Fixed manufacturing Overhead	$3,538,000.00	$0.00	$3,538,000.00
Total Cost	$12,468,000.00	$12,784,000.00	-$316,000.00

Solution c:

Differential Analysis- Cane Company - Making Alpha (alt 1) or Buying Alpha (Alt2)
Particulars	Making Alpha (Alt 1)	Buying Alpha (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (69000*$136)	$0.00	$9,384,000.00	-$9,384,000.00
Direct material	$2,760,000.00	$0.00	$2,760,000.00
Direct Labor	$2,346,000.00	$0.00	$2,346,000.00
Variable manufacturing overhead	$1,449,000.00	$0.00	$1,449,000.00
Avoidable Fixed manufacturing Overhead	$3,538,000.00	$0.00	$3,538,000.00
Total Cost	$10,093,000.00	$9,384,000.00	$709,000.00

Solution d:

Pound of raw material needed for one unit of Alpha = $40 / $8 = 5 pound

Pound of raw material needed for one unit of Beta = $24 / $8 = 3 pound