Question

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 $90,000 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 100,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:

Direct material	$	3.60
Direct labor		2.00
Manufacturing overhead		1.40
Total cost	$	7.00

The costs above relate to making both the lip balm and the tube that contains it. As an alternative to making the tubes for Chap-Off, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $1.35 per box of 24 tubes. If Silven Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 25%.

Required:

1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able to avoid? (Hint: You need to separate the manufacturing overhead of $1.40 per box thet is shown above into its variable and fixed components to derive the correct answer.)

2. What is the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier?

3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 100,000 boxes of tubes from the outside supplier?

4. Should Silven Industries make or buy the tubes?

5. What is the maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes?

6. Instead of sales of 100,000 boxes of tubes, revised estimates show a sales volume of 120,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra equipment at a cost of $40,000 per year to make the additional 20,000 boxes of tubes. Assuming that the outside supplier will not accept an order for less than 120,000 boxes of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven buys 120,000 boxes of tubes from the outside supplier? Given this new information, should Silven Industries make or buy the tubes?

7. Refer to the data in (6) above. Assume that the outside supplier will accept an order of any size for the tubes at a price of $1.35 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?

Answer 1

REQUIREMENTS:

1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able to avoid.

Tubes own manufacturing costs per box to avoid = $ 1.15

Particulars Making cost per box   

Direct Material $ 0.90 ($3.60*25%)   

Direct Labour $ 0.20 ($2.00*10%)

Variable Mfg OH $ 0.05 ($0.50*10%)

( $ 1.40 - $ 0.90 Fixed OH)

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Total $ 1.15

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Fixed Mfg OH cost is irrelevant for decision making.

2. What is the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier.

financial advantage :-

if purchase outside Capacity release to making the tubes for Chap-off and use spare capacity for alternative use. that spare capacity derived income over and excess of saving cost if make tubes.

   financial disadvantage :-

if purchase outside we are paying extra costs for tubes then own make tubes.

$1.35 - $1.15 = $ 0.20 per box (24tubes)

3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 100,000 boxes of tubes from the outside supplier?

financial disadvantage :-

if purchase outside we are paying extra costs for tubes.

outside purchase cost for 100,000 boxes (tubes) = 100000 * $ 1.35 = $ 1,35,000

own manufacturing cost for 100,000 boxes (tubes) = 100000 * $ 1.15 = $ 1,15,000

extra cost paid = ($ 1,35,000- $ 1,15,000) = $ 20,000

financial advantage :-

if we used released spare capacity for alternative use and received income above $ 20,000 then it is financial advantage for Silven Industries.

4. Should Silven Industries make or buy the tubes.

Particulars Making cost per box outside purchase cost per box

Direct Material $ 0.90 ($3.60*25%) --

Direct Labour $ 0.20 ($2.00*10%) --

Variable Mfg OH $ 0.05 ($0.50*10%) --

( $ 1.40 - $ 0.90 Fixed OH)

Purchase Cost (outside) -- $ 1.35

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Total $ 1.15 $ 1.35

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we should make the tubes because achived benefit ($ 1.35 - $ 1.15) = $ 0.20 per box.

Fixed cost is irrelevant for decision making.

5. What is the maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes.

maximum price should be pay the outside supplier for box of 24 tubes =$1.15 (Only Variable Cost)

6. what is the financial advantage (disadvantage) in total (not per box) if Silven buys 120,000 boxes of tubes from the outside supplier? Given this new information, should Silven Industries make or buy the tubes?

financial advantage:

if Silven buys 120,000 boxes of tubes from the outside supplier then we save Additional fixed cost incurred for making tubes $ 40,000.

we  pay extra $ 0.20 per box ( i.e. 120000 * $ 0.20 = $ 24,000)

but net saving cost (i.e. $ 40,000 - $ 24,000 = $ 16,000)

  

financial disadvantage :-

if purchase outside company have disadvantage company had depend on outsider. if sales demand down below from 120000 boxes then supplier not accept purchase order below 120000 boxes.

Should Silven Industries make or buy the tubes.

Particulars Making cost per box outside purchase cost per box

Direct Material $ 0.90 ($3.60*25%) --

Direct Labour $ 0.20 ($2.00*10%) --

Variable Mfg OH $ 0.05 ($0.50*10%) --

( $ 1.40 - $ 0.90 Fixed OH)

Purchase Cost (outside) -- $ 1.35

--------------------------------------------------------

Total $ 1.15 $ 1.35

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when we make the tubes we achived benefit ($ 1.35 - $ 1.15) = $ 0.20 per box.

(i.e. 120000 * $ 0.20) = $ 24,000 for 120000 boxes.

we incurred additional fixed cost for produce 12000 boxes = $ 40,000

Net loss ($ 40,000 - $ 24,000) = $ 16,000

we should buy the tubes from outside supplier , because we save cost $ 16,000

Additional Fixed cost is relevant for decision making.

7. Refer to the data in (6) above. Assume that the outside supplier will accept an order of any size for the tubes at a price of $1.35 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?

if outside supplier will accept an order of any size for the tubes at a price of $1.35 per box. Then we make 100000 boxes tube and purchase from outside supplier 20000 boxes tubes.

Total Benefit = $ 56,000

Make Benefit = 100000 * $ 0.20 = $ 20,000

Purchase Benefit = $ 40000 - ( 20000 * $ 0.20) = $36,000

(AFC - Extra Cost)