Question

roblem 14-21 Make or Buy Decision [LO3]

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 $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product.
However, a $88,920 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 114,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box:
   
       Direct materials$2.9    Direct labor1.0    Manufacturing overhead2.2    Total cost
$6.1  
   
        The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be $1.16 per box of 24 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 7% and direct materials costs would be reduced by 33%.
    
 
Requirement 1:(a)
Calculate the total variable cost of one box of Chap-Off if the company manufactures all of its own tubes from start to finish. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
   
 
  Total variable cost per box$ 

 
 
(b)
Calculate the total variable cost of one box of Chap-Off if the tubes are purchased from the outside supplier. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
   
 
  Total variable cost per box$ 
   
 
(c)Should Silven Industries accept/reject the outside supplier's offer?     (Click to select)AcceptReject
    
Requirement 2:
What is the maximum price that Silven Industries should be willing to pay the outside supplier per box of 24 tubes? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
   
 
  Maximum price$ per box  
   
Requirement 3:
Instead of sales of 114,000 boxes, revised estimates show a sales volume of 129,000 boxes. At this new volume, additional equipment must be acquired to manufacture the tubes at an annual rental of $48,000. Calculate the cost under the three alternatives. (Round your total variable cost per box to 2 decimal places. Omit the "$" sign in your response.)
    
 
(a)Total variable cost to produce 129,000 boxes of Chap-off, if all tubes required are produced internally:
   
 
  Total Variable Cost$  
   
(b)Total variable cost to produce 129,000 boxes of Chap-off, if all tubes required are purchased externally:
   
 
  Total Variable Cost$  
   
 
(c)What is the total variable cost of producing 129,000 boxes of Chap-off, if 114,000 Chap-off boxes are produced with tubes manufactured internally and tubes for remaining 15,000 Chap-off boxes are purchased externally?
   
 
  Total Variable Cost$  

Answer 1

1- a & b) Calculation of variable cost per box (Amounts in $)

Costs	If tubes are manufactured (a)	If tubes are purchased (b)
Direct Material Cost	$2.90	1.94 (2.90*67%)
Direct Labor Cost	$1.00	0.93 (1.00*93%)
Variable Manufacturing Overhead	$1.42	1.32 (1.42*93%)
Total variable cost per box	5.32	4.19

Working Note:- Separation of Manufacturing Overhead into Fixed and Variable

Total Fixed Overhead absorbed for this product given in the question = $88,920

Total Boxes Produced = 114,000

Fixed overhead absorption rate per box = 88,920/114,000 = $0.78 per box

Variable manufacturing overhead = $2.2 - $0.78 = $1.42

1-c) Decrease in variable cost if tubes are purchased from outside supplier is $1.13 (5.32-4.19) and purchase price of tube is $1.16 per box. As saving in variable cost is less than the purchase cost, Silven industries should not accept the outside supplier's offer.

2) The maximum saving in cost per box of tube by buying tubes from outside supplier is $1.13, thus the company will pay up to $1.13 per box of tube only. Thus the maximum price that Silven industries would be willing to pay per box of tube is $1.13.

3-a) Total Variable cost if produced internally = (129,000*Variable cost per unit)+Cost of additional equipment

= (129,000 boxes*$5.32 per box)+$48,000

= $686,280+$48,000 = $734,280

3-b) Total variable cost if purchased externally = 129,000 boxes*($4.19+$1.16)

= 129,000 boxes*$5.35 = $690,150

3-c) If 114,000 boxes are produced with tubes produced internally and 15,000 boxes with tubes purchased externally.

Total variable cost = (114,000 boxes*$5.32)+(15,000 boxes*$5.35)

= $606,480+$80,250 = $686,730

The best alternative is c as the variable cost of lower in this alternative.