Question

Drugs-R-Us, Inc., produces equipment for manufacturing drugs. The costs of manufacturing and marketing this equipment at the company's normal volume of 3,000 units per month are shown in Exhibit 1.

                                                          EXHIBIT 1 - Costs per Unit for Equipment

Unit manufacturing costs:

            Variable materials                                        $200

            Variable labor                                                 300

            Variable overhead                                        150

            Fixed overhead                                             240

                       Total unit manufacturing costs                                 $   890

Unit marketing costs:

            Variable                                                        $100

            Fixed                                                            280

                       Total unit marketing costs                                        $   380

Total unit costs                                                                                $1,270

The following questions refer only to the data given above. Unless otherwise stated, assume there is no connection between the situations described in the questions; each is to be treated independently. Unless otherwise stated, a regular selling price of $1,580 per unit should be assumed. Ignore income taxes and other costs that are not mentioned in Exhibit 1 or in the question.

1.   What is the contribution margin per unit and in total for the equipment? What does this mean?

2.   What is the breakeven volume in units? In sales dollars?

3.   Market research estimates that monthly equipment production could be increased to 3,500 units which is well within production capacity limitations, if the price were cut from $1,580 to $1,400 per unit. Assuming the cost behavior patterns implied by the data in Exhibit 1 are correct, would you recommend that this action be taken? What would be the impact on monthly sales, costs, and income?

4.   Drugs-R-Us has an opportunity to enter a foreign market in which price competition is keen. An attraction of the foreign market is that demand there is greatest when demand in the domestic market is quite low; thus, idle production facilities could be used without affecting domestic business. Unlike many foreign markets there are no government restrictions. An order for 1,000 units is being sought at a below-normal price in order to enter this market. Additional shipping and handling costs for this order will amount to $150 per unit, while the cost of obtaining the contract (marketing costs) will be $8,000 in addition to the normal variable marketing costs. Domestic business would be unaffected by this order. What is the minimum (e.g. breakeven) unit price Drugs-R-Us should consider for this order of 1,000 units?

		Per Unit	Total	Relevant???
Variable Costs	Materials	$         200	$ 200,000
	Labor	$         300	$ 300,000
	Overhead	$         150	$ 150,000
	Marketing	$         100	$ 100,000
	Shipping	$         150	$ 150,000
Fixed Costs	Mfg OH	$         240	$ 240,000
	Marketing	$         280	$ 280,000
	Contract	$        8000	$     8,000

How can I fill out the Relevant???

5.   An inventory of 230 units of equipment remains in the stockroom. These must be sold through regular channels at reduced prices or the inventory will soon be valueless. What is the minimum price that would be acceptable for selling these units?

Any price > variable cost of selling/marketing the units

I need answer only for number 4 and 5

Answer 1

Requirement 1:

Particulars	Per unit	Total
Sales	1580	4740000
Less:
Variable Costs
Direct Material	200
Direct Labor	300
Variable OH	150
Variable Marketing cost	100
Total Variable Cost	750	2250000
Total Contribution Margin	830	2490000
Less - Fixed Costs :
Fixed Overhead	240	720000
Fixed marketing costs	280	840000
Total Fixed Costs	520	1560000
Net Profit	310	930000

Contribution margin ratio = 830/1580 =52.53%

Requirement 2:

Break even volume in units = Fixed costs/Contribution per unit = 1560000/830 = 1880 units

Break even volume in Dollars = Fixed Costs/Contribution margin ratio = 1560000/52.53% = $ 2,969,640

Requirement 3:

Particulars	Per unit	Total
Sales	1400	5530000
Less:
Variable Costs
Direct Material	200
Direct Labor	300
Variable OH	150
Variable Marketing cost	100
Total Variable Cost	750	2625000
Total Contribution	650	2905000
Less - Fixed Costs :
Fixed Overhead	240	840000
Fixed marketing costs	280	980000
Total Fixed Costs	520	1820000
Net Profit	130	1085000

It is recommended to undertook the proposed price cut as the overall income has increased from 930,000 to 1,085,000 even though the Net profit per unit was reduced.

Requirement 4:

Particulars	Per unit	Total	Relevant or not?
Variable Costs:
Direct Material	200	200000	Relevant costs
Direct Labor	300	300000	Relevant costs
Variable OH	150	150000	Relevant costs
Variable Marketing cost	100	100000	Relevant costs
Shipping costs	150	150000	Relevant costs
Fixed Costs :
Fixed Mfg Overhead	240	720000	Irrelevant costs
Contract obtaining costs		8000	Relevant costs
Fixed marketing costs	280	980000	Irrelevant costs

Fixed Mfg OH & Fixed Marketing Costs are irrelevant as they are already incurred & not additional costs.

Inorder to be relevant it has to be incremental & in cash flows & is a future cost

Minimum unit price for this Contract = Total Relevant cost per unit

= 150+100+150+300+200 = 900 * 1000 = 900,000+8000 = 908000/1000 = 908 per unit

Requirement 5:

Minimum price per unit will be the variable costs incurred to produce the products

That is Direct material + direct labor + variable OH = 200+300+150 = 650 per unit

Therefore, minimum price for sale of 230 units inventory = 650 per unit