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 $13 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $87,500 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 125,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:

Direct material	$	5.60
Direct labor		4.00
Manufacturing overhead		2.40
Total cost	$	12.00

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 $1.90 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 20%.

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 $2.40 per box that 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 125,000 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 125,000 boxes of tubes, revised estimates show a sales volume of 155,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra equipment at a cost of $50,000 per year to make the additional 30,000 boxes of tubes. Assuming that the outside supplier will not accept an order for less than 155,000 boxes of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven buys 155,000 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 $1.90 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?

Answer 1

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Silven Industries	Amount $
Calculation of variable manufacturing overhead
Manufacturing overhead per box	2.40	A
Number of boxes	125,000.00	B
Total Manufacturing overhead	300,000.00	C=A*B
Less: Allocated fixed Manufacturing overhead	87,500.00	D
Variable Manufacturing overhead	212,500.00	E=C-D
Variable Manufacturing overhead per box	1.70	F=E/B
Direct Materials	5.60
Direct Labor	4.00
Variable Manufacturing overhead per box	1.70	See F
Variable cost of one box	11.30	G

Calculation of revised variable costs	Direct Labor	Variable Manufacturing overhead
Cost per box	4.00	1.70	H
Decrease by	10%	10%	I
Decrease by	0.40	0.17	J=H*I
Revised variable costs	3.60	1.53	K=H-J

Calculation of revised Direct Materials costs	Direct Labor
Cost per box	5.60	L
Decrease by	20%	M
Decrease by	1.12	N=L*M
Revised Direct Materials costs	4.48	O=L-N
Answer 1
Decrease in Direct Material	1.12	See N
Decrease in Direct Labor	0.40	See J
Decrease in Variable Manufacturing Overhead	0.17	See J
Avoidable Manufacturing cost per box	1.69
Answer 2
Revised Variable cost of one box
Direct Materials	4.48	See O
Direct Labor	3.60	See K
Variable Manufacturing overhead per box	1.53	See K
Cost per box of tubes	1.90
Revised Variable cost of one box	11.51	P
Variable cost of one box if tubes were made	11.30
Financial disadvantage per box	0.21

Answer 3
Financial disadvantage per box	0.21
Total boxes purchased	125,000.00
Total Financial disadvantage	26,250.00

Answer 4

Variable cost of one box is $ 11.51 if tubes are purchased and $ 11.30 if tubes are produced. The cost will increase by $ 0.21 if tubes were purchased so NO tubes should not be purchased. They should be made.

Answer 5
Revised Variable cost of one box
Direct Materials	4.48	See O
Direct Labor	3.60	See K
Variable Manufacturing overhead per box	1.53	See K
Variable cost of one box without tubes	9.61	Q
Variable cost of one box if tubes were made	11.30	See G
Cost per box of tubes should be	1.69	R= G-Q

So the maximum purchase price should be the savings per box which is $ 1.69.

Answer 6
Variable cost per box if boxes made	11.30	See G
Number of boxes	155,000.00	S
Total Variable cost	1,751,500.00	T=S*G
Add: equipment rental	50,000.00	U
Total relevant cost of 155,000 boxes	1,801,500.00	V=T+U
Variable cost per box if tubes purchased	11.51	See P
Number of boxes	155,000.00	S
Total relevant cost of 197,000 boxes	1,784,050.00	W=P*S
Total Financial advantage	17,450.00

Total relevant cost is $ 1,801,500 if tubes are purchased and $ 1,784,050 if tubes are produced. Silven has net financial advantage of $ 17,450 if tubes were purchased. So yes tubes should be purchased and they should not be made.

Answer 7	Make 125,000 boxes	Buy 30,000 boxes	Total
Variable cost of one box	11.30	11.51
Number of boxes	125,000.00	30,000.00
Total Variable	1,412,500.00	345,300.00	1,757,800.00

The cost is least if 125,000 boxes are made and tubes for remaining 30,000 boxes are purchased. So the company should make 125,00 boxes and buy 30,000 boxes.