Question

Thornton Chemical Company makes a variety of cosmetic products, one of which is a skin cream designed to reduce the signs of aging. Thornton produces a relatively small amount (16,000 units) of the cream and is considering the purchase of the product from an outside supplier for $5.80 each. If Thornton purchases from the outside supplier, it would continue to sell and distribute the cream under its own brand name. Thornton’s accountant constructed the following profitability analysis: Revenue (16,000 units × $14.50) $ 232,000 Unit-level materials costs (16,000 units × $1.80) (28,800 ) Unit-level labor costs (16,000 units × $0.80) (12,800 ) Unit-level overhead costs (16,000 × $0.20) (3,200 ) Unit-level selling expenses (16,000 × $0.10) (1,600 ) Contribution margin 185,600 Skin cream production supervisor’s salary (60,000 ) Allocated portion of facility-level costs (13,200 ) Product-level advertising cost (41,000 ) Contribution to companywide income $ 71,400 Required Identify the cost items relevant to the make-or-outsource decision. What is the avoidable cost per unit if the outsourcing decision is taken? Should Thornton continue to make the product or buy it from the supplier? Suppose that Thornton is able to increase sales by 12,000 units (sales will increase to 28,000 units). Calculate the total avoidable costs. At this level of production, should Thornton make or buy the cream?

Answer 1

Req a:
Avoidable cost peer unit:
Material cost per unit				1.8
Labour cost				0.8
Overheads cost				0.2
Product Superviser salary (60000/16000)				3.75
Avoidable cost per unit				6.55
The companny shall buy the Incre-cream as it is available at $5.80 and savings in cost of manufacture is 6.55 per unit
Hence, Financial advantage is of 0.75 per unit
Req b:
Total avaoidable cost at 28000 units
Total avoidable:
Material cost			50400
Labour cost			22400
Overheads cost			5600
Product Supervisor salary			60000
Total avoidable cost			138400
Cost of Buying (28000*5.80)			162400
Now, the Company must produce the ice-cream ata level of 28000 units
It will Give net financial advantage of $24000