Question

Problem 10-23A Make or Buy Decision [LO10-3]

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 12 tubes for $8.50 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $110,000 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 cost per box:

Direct materials	$	4.80
Direct labor		1.00
Manufacturing overhead		1.40
Total cost	$	7.20

The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be $1.20 per box of 12 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 20%.

  

Required:
1a.	Calculate the total variable cost of producing one box of Chap-Off. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
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1b.	Assume that the tubes for the Chap-Off are purchased from the outside supplier, calculate the total variable cost of producing one box of Chap-Off. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
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1c.	Should Silven Industries make or buy the tubes?
	Make Buy

   

2.	What would be the maximum purchase price acceptable to Silven Industries? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
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3.	Instead of sales of 100,000 boxes, revised estimates show a sales volume of 115,000 boxes. At this new volume, additional equipment must be acquired to manufacture the tubes at an annual rental of $32,000. Assume that the outside supplier will not accept an order for less than 115,000 boxes.

a.	Calculate the total relevant cost of making 115,000 boxes and total relevant cost of buying 115,000 boxes. (Do not round intermediate calculations.)
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b.	Based on the above calculations, should Silven Industries make or buy the boxes?
	Make Buy

  

4.	Refer to the data in (3) above. Assume that the outside supplier will accept an order of any size for the tubes at $1.20 per box. Which of these is the best alternative?
	Make all 115,000 boxes Buy all 115,000 boxes Make 100,000 boxes and buy 15,000 boxes Make 32,000 boxes and buy 32,000 boxes

Answer 1

As per policy only first four questions will be answered

Part 1A

Total manufacturing overhead cost per box of Chap-Off.. $1.40

Less fixed portion ($110,000 ÷ 100,000 boxes)............... 1.10

Variable overhead cost per box..................................... $0.30

The total variable cost of producing one box of Chap-Off would be:

Direct materials .......................................................... $4.80

Direct labor ................................................................ 1.00

Variable manufacturing overhead.................................. 0.30

Total variable cost per box ........................................... $6.10

Part 1B

Direct materials ($4.80 * 80%).................................... $3.84

Direct labor ($1.00 * 90%).......................................... 0.90

Variable manufacturing overhead ($0.30 * 90%)........... 0.27

Cost of tube from outside ............................................ 1.20

Total variable cost per box ........................................... $6.21

Part 1C

The company should reject the outside supplier’s offer. A savings of $0.11 (6.21-6.10) per box of Chap-Off will be realized by producing the tubes internally.

Part 2

The maximum purchase price would be $1.09 per box. The company would not be willing to pay more than this amount because the $1.09 represents the cost of producing one box of tubes internally. To make purchasing the tubes attractive, however, the purchase price should be less than $1.09 per box.

Cost avoided by purchasing the tubes:

Direct materials ($4.80 * 20%) ........................... $0.96

Direct labor ($1.00 * 10%) ................................. 0.10

Variable manufacturing overhead ($0.30 * 10%) .. 0.03

Total costs avoided................................................ $1.09