Question

Silven 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, Silven’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 $9 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $139,500 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 155,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:

Direct material	$	4.30
Direct labor		2.60
Manufacturing overhead		1.90
Total cost	$	8.80

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, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $1.35 per box of 24 tubes. If Silven 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 20%.

Required:

1. If Silven 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 $1.90 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 Silven buys its tubes from the outside supplier?

3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 155,000 boxes of tubes from the outside supplier?

4. Should Silven Industries make or buy the tubes?

5. What is the maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes?

6. Instead of sales of 155,000 boxes of tubes, revised estimates show a sales volume of 191,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra equipment at a cost of $56,000 per year to make the additional 36,000 boxes of tubes. Assuming that the outside supplier will not accept an order for less than 191,000 boxes of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven buys 191,000 boxes of tubes from the outside supplier? Given this new information, should Silven Industries make or buy the tubes?

7. Refer to the data in (6) above. Assume that the outside supplier will accept an order of any size for the tubes at a price of $1.35 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?

Answer 1

Bifurcation of Manufacturing Overhead into Fixed and Variable Cost
Total units produced	155,000
Manufacturing Overhead per unit	$1.90
Total Manufacturing Overhead	$294,500
Less:
Fixed Manufacturing Overhead	$139,500
Variable Manufacturing Overhead	$155,000
Total units produced	155,000
Variable Manufacturing Overhead per unit	$1.00
1.
Computation of costs avoided per box if the tubes are bought from outside supplier
	Cost per box	Reduction%	Costs avoided per box
Direct Material	$4.30	0.20	$0.86
Direct Labor	$2.60	0.10	$0.26
Variable Manufacturing Overhead	$1.00	0.10	$0.10
Total	$7.90		$1.22
2.
Computation of financial advantage/ (disadvantage) if the tubes are bought from outside
supplier
	Own Production	Outside Supplier
Direct Material	$4.30	$3.44
Direct Labor	$2.60	$2.34
Variable Manufacturing Overhead	$1.00	$0.90
Fixed Manufacturing Overhead	$0.90	$0.90
Purchase Cost of Tubes	$0.00	$1.35
Total Cost per box	$8.80	$8.93
Costs per box if tubes are produced by Silven	$8.80
Costs per box if tubes are bought from Outside supplier	$8.93
Financial Advantage/(Disadvantage)	($0.13)
3.
Total number of boxes bought	155,000
Financial disadvantage per box	($0.13)
Total Financial disadvantage	($20,150)
4.
Since, the cost of producing the boxes is cheaper than the cost of purchasing the
boxes from outside supplier by $ 20,150, Silven should buy the tubes.
5.
The maximum price which Silven will be willing to pay to the outside supplier would
the value of the costs avoided if it accepts the offer to buy the tubes.
Cost avoided per box if the tubes are purchased from outside supplier (as computed in question -1 above)	$1.22
Maximum price that Silven would pay for a box to outside supplier	$1.22
6.
	Own Production	Outside Supplier
Allocated Fixed Costs	$139,500	$139,500
Add: Rent on equipment	$56,000	$0
Total Fixed Costs	$195,500	$139,500
Total boxes manufactured	$191,000	$191,000
Fixed costs per box	$1.02	$0.73
Computation of cost per box at 191,000 volume
	Own Production	Outside Supplier
Direct Material	$4.30	$3.44
Direct Labor	$2.60	$2.34
Variable Manufacturing Overhead	$1.00	$0.90
Fixed Manufacturing Overhead	$1.02	$0.73
Purchase Cost of Tubes	$0.00	$1.35
Total cost per box	$8.92	$8.76
Since,the cost per box is lower if Silven buys from the outside supplier,hence in this
scenario,Silven Industries should buy the tubes
7.
The cost for making 155,000 is lower in comparision to purchasing from outside
supplier
Cost of making the tubes per box	$8.80
Cost of purchasing the tubes per box	$8.93
For additional manufacturing,Silvem Industries need to incurr additional fixed costs of
$ 56,000 which results in change in cost per box as under:
Cost of making the tubes per box	$8.92
Cost of purchasing the tubes per box	$8.76
Hence, Silven Industries should make 155,000 boxes where the cost per box to make
is lower.
For, the additional boxes, Silven Idustries should buy it from outside supplier at the
agreed price of $ 1.35 per box, because it will have to incurr additional fixed cost of
$ 56,000 to make the boxes which would result in higher cost per box as stated above