Question

Blast-It-Out-Musical Instruments manufactured 6,250 electronic pickups that were used in its guitars and 4 and 5 string basses and incurred the following costs: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead $30,500 15,000 10,000 20,000 $75,500 Muffled Assemblies has offered to sell the same electronic pickup to Blast-It-Out for $13.75 per unit. The fixed manufacturing overhead of Blast It Out consists mainly of depreciation on the equipment used to manufacture the electronic pickup and would not be reduced if the electronic pick up was purchased from Muffled. If the electronic pickup is purchased from Muffled, Blast It Out has the opportunity to use the factory equipment to produce a 6-string bass which is not currently in its product line and which is estimated to have a contribution margin of $25,750. Prepare an analysis and recommend what Blast-It-Out should do.

Answer 1

Fixed Cost are irrelevant for decision making as it will be incurred as on depreciation component

Blast it out musical instrument manufactured 6250electronic pickup and 4 and 5 string basses.

It has Incurred the variable cost of $ 55500 and fixed cost of $2000 making the total cost = $ 75500.

If we take base to the units manufactured per unit cost of musical Instrument = 75500/6250 = $12.08.

and variable per unit cost = 55500 / 6250 = $8.8 per unit.

Now, Muffled Assemblies has offere to sell electronic pickup @13.75.

if we take base for cost of 6250 units @13.75 = variable cost = 85938.

Accepting this offer will earn a additional contribution margin of $ 25750. due to a new product line can be started.

However The increment of Variable cost due to accepting the offer = $85938- $55500. = $30437.5 and increment in contribution is only $ 25750.

Since the contribution margin p.u and in total will reduce due to acceptance of proposal. Hence Blast it out should not accept the proposal and continue with existing process. Increase in Production will eat up the additional fixed cost making more profit in near future.