Question

Cane Company manufactures two products called Alpha and Beta that sell for $180 and $145, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity to annually produce 118,000 units of each product. Its unit costs for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	36			$	24
Direct labor			32				27
Variable manufacturing overhead			19				17
Traceable fixed manufacturing overhead			27				30
Variable selling expenses			24				20
Common fixed expenses			27				22
Total cost per unit		$	165			$	140

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

1. Assume that Cane normally produces and sells 102,000 Betas per year. If Cane discontinues the Beta product line, how much will profits increase or decrease?

2. Assume that Cane normally produces and sells 52,000 Betas per year. If Cane discontinues the Beta product line, how much will profits increase or decrease?

3. Assume that Cane expects to produce and sell 62,000 Alphas during the current year. A supplier has offered to manufacture and deliver 62,000 Alphas to Cane for a price of $128 per unit. If Cane buys 62,000 units from the supplier instead of making those units, how much will profits increase or decrease?

Answer 1

1. Profits decrease by $2274000

	Beta (102000 units)
	Per unit $	Total $
Sales	145	14790000
Less: Variable costs
Direct materials	24	2448000
Direct labor	27	2754000
Manufacturing overhead	17	1734000
Selling expenses	20	2040000
Total variable costs	88	8976000
Contribution margin lost	57	5814000
Less: Savings in traceable fixed manufacturing overhead	30	3540000
(118000 x $30)
Net (increase)/decrease in profits $		2274000

2. Profits increase by $576000

	Beta (52000 units)
	Per unit $	Total $
Sales	145	7540000
Less: Variable costs
Direct materials	24	1248000
Direct labor	27	1404000
Manufacturing overhead	17	884000
Selling expenses	20	1040000
Total variable costs	88	4576000
Contribution margin lost	57	2964000
Less: Savings in traceable fixed manufacturing overhead	30	3540000
(118000 x $30)
Net (increase)/decrease in profits $		-576000

3. Profits increase by $644000

	Make Alphas (62000 units)		Buy Alphas (62000 units)		Differential: Increase (Decrease) in Profits
	Per unit $	Total cost $	Per unit $	Total cost $
Direct materials	36	2232000	0	0	2232000
Direct labor	32	1984000	0	0	1984000
Variable manufacturing overhead	19	1178000	0	0	1178000
Traceable fixed manufacturing overhead (118000 x $27)		3186000	0	0	3186000
Purchase cost	0	0	128	7936000	-7936000
Net increase / (decrease) in profits $		8580000		7936000	644000

Note: The selling price and variable selling expenses will not change with the alternatives and hence are irrelevant. Common fixed expenses are unavoidable and hence irrelevant as they too will not change with the alternatives.