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 14 tubes for $6.20 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $50,000 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	$	2.50
Direct labor		1.00
Manufacturing overhead		1.40
Total cost	$	4.90

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 $1.00 per box of 14 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.)

  

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.)

  

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.)

     

3.	Instead of sales of 100,000 boxes, revised estimates show a sales volume of 112,000 boxes. At this new volume, additional equipment must be acquired to manufacture the tubes at an annual rental of $46,000. Assume that the outside supplier will not accept an order for less than 112,000 boxes.

a.	Calculate the total relevant cost of making 112,000 boxes and total relevant cost of buying 112,000 boxes. (Do not round intermediate calculations.)

  

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 $1.00 per box. Which of these is the best alternative?
	Make all 112,000 boxes Buy all 112,000 boxes Make 100,000 boxes and buy 12,000 boxes Make 46,000 boxes and buy 46,000 boxes

Answer 1

W/Note:-1

Fixed Manufacturing Overhead per Box ($50000/100000 Boxes)=$0.50/Box

1.a Computation of Total Variable Cost of Producing On eBox of Chap Off
Particular	Amount
Direct Material	$2.50
Direct Labour	$1.00
Variable Manufacturing Overhead (w/Note-1)	$0.50
Total variable Cost/Box	$4.00

1.b. Variable Cost of Producing One Box of Chap off ( if purchased from Outside Supplier)
Particular	Amount
Direct Material ($2.50*80%)	$2.00
Direct Labour ($1*90%)	$0.90
Variable Manufacturing Overhead ($0.50*90%)	$0.45
Supplier Price for Empty Tube	$1.00
Total variable Cost/Box	$4.35

1.c Make because , Variable cost /Box under Option -1 is cheaper than option-2 and net saving will be ($4.35-$4.00)=$0.35

Answer 2. Maximum purchase price of empty chap-off tube should be a price which will equalize variable cost per tube with its manufacturing cost. As the difference is $0.35 per box, existing purchase price should be reduced by $0.35 at least to make the situation indifferent. Thus maximum purchase price acceptable is $1-$0.35 = $0.65..

Answer 3(a). Now the company has to manufacture 112000 box instead of 100,000 box. This extra production is possible by introducing a new machine. Rental of new machine is a relevant cost when tubes are manufactured. When tubes are purchased from outside it is not required. Further common share of fixed manufacturing overhead is not all relevant cost. Thus total cost of manufacturing and purchasing 112,000 tubes will be-

	Cost when tubes are	Cost when tubes are
	manufactured	purchased
Direct material	112,000x$2.50=$280000	112,000x$2=$224,000
Direct labor	112,000x$1.00=$112000	112,000x$0.90=$100800
Variable mfg overhead	112000x0.50=$56,000	112,000x$0.45=$50400
Purchase price of tubes	nil	112000x1=$112,000
Rental of machine	$46,000.00
Total relevant cost	$494,000	$487,200

Answer-3(b): Based on total cost of answer 3(a) buying tubes from outside is a better decision. It will lower relevant cost and will maximize profit.

4. It's Worthful to manufacture 100000 unit and Purchase 12000 unit from Outside supplier. Thus relevant cost is- (100,000X$4.00+12000*$4.35)=$452200