Question

Cane Company manufactures two products called Alpha and Beta that sell for $225 and $175, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity to annually produce 130,000 units of each product. Its average cost per unit for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	42			$	24
Direct labor			42				32
Variable manufacturing overhead			26				24
Traceable fixed manufacturing overhead			34				37
Variable selling expenses			31				27
Common fixed expenses			34				29
Total cost per unit		$	209			$	173

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are unavoidable and have been allocated to products based on sales dollars.

1. Assume that Cane expects to produce and sell 74,000 Alphas during the current year. A supplier has offered to manufacture and deliver 74,000 Alphas to Cane for a price of $156 per unit. What is the financial advantage (disadvantage) of buying 74,000 units from the supplier instead of making those units?

2. Assume that Cane’s customers would buy a maximum of 99,000 units of Alpha and 79,000 units of Beta. Also assume that the company’s raw material available for production is limited to 344,000 pounds. If Cane uses its 344,000 pounds of raw materials, up to how much should it be willing to pay per pound for additional raw materials? (Round your answer to 2 decimal places.)

Answer 1

1.

	Make	Buy
Units	74,000
Cost of buying (74000*$156)		11,544,000
Direct materials (74000*42)	3,108,000
Direct labor (74000*42)	3,108,000
Variable manufacturing overhead (74000*26)	1,924,000
Traceable fixed manufacturing overhead (130000*34)	4,420,000
Variable selling expenses	0
Common fixed expenses	0
Total costs	12,560,000	11,544,000
Difference in cost	1,016,000

As the total costs for buying is lower than the total cost for making then there is a financial advantage of buying 74,000 units from the supplier. The amount of financial advantage is $1,016,000

Explanation: Variable selling expenses and common fixed expenses will be incurred whether the offer is accepted or not and hence have not been included in the above calculation.

2. We will first compute pounds of raw material needed to make one unit of Alpha and Beta.

	Alpha	Beta
Direct materials	42	24
price per pound	6	6
pounds per unit	7	4

The next step is to compute contribution margin per pound of raw material.

	Alpha	Beta
Selling price per unit	225	175
Variable cost per unit	141	107
Contribution margin	84	68
pounds per product	7	4
Contribution margin per pound	12	17

(Note that variable costs = direct materail+direct labor+variable manufacturing overhead+variable selling expenses) (12 = 84/7) (17 = 68/4)

As contribution margin per pound for Beta is more than Alpha the requirements for Beta will be met first and hence additional raw materials will be needed for Alpha.

Now, regular cost per pound = $6. Contribution margin per pound for Alpha = $12.

Thus maximum price per pound of additional raw materails that it will be willing to pay = 6+12 = $18.00