Question

In: Accounting

Drugs-R-Us, Inc., produces equipment for manufacturing drugs. The costs of manufacturing and marketing this equipment at...

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.   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?

2.   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???

How can I distinguish between relevant cost and irrelevant cost?

3.   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

Solutions

Expert Solution

1.

If price cut down to $1400 per unit, production volume increased to 3500 units

If selling price $1500 then

Profit= selling price - total unit cost

Profit= 1500- 1270 = $ 230

Total profit of 3000 units = $230 × 3000= $ 690000

If selling price $1400 then

Profit = $1400 - 1270 = $ 130

Total profit of 3500 units= $130 × 3500 = $ 455000

Difference = $235000

If price cut down then profit will decrease by $235000.

2. Break even unit selling price= fixed cost + variable cost per unit

Variable material 200 Relevant
Variable labor 300 Relevant
Variable OH 150 relevant
Variable marketing cost 100 relevant
Shipping cost 150 relevant
Fixed manuf. OH 240 relevant
Cost of contract 8000÷1000 8 relevant
Total cost 1148

Fixed marketing cost which is irrelevant here to consider because it is remained whether contract of 1000 units received or not.

Difference between Relevant and Irrelevant cost

It is the classification of cost important in managerial decision. Relevant cost which is affected by managerial decision and irrelevant cost which is not affected by managerial decision.

Irrelevant cost which is not dependent on decisions, it is same in different alternatives and on the other hand relevant cost is different in various alternatives.

3. Minimum price of inventory remains in stockroom

= Releasable value or variable cost less disposal value.


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