Question

Toys for fun Co. is working at full production capacity producing 20,000 units of a unique product, OB1. Sale price and costs per unit for OB1 are as follows:

            Sale price                                 $ 40

Direct materials                        $ 5

            Direct manufacturing labour     $ 8

            Manufacturing overhead          $ 14

Selling costs (all variable)          $ 8

The unit manufacturing overhead cost is based on a variable cost per unit of $10 and fixed costs of $80,000 (at full capacity of 20,000 units).

A Chinese customer, Zhao Co., has asked Toys for fun Co. to produce 4,000 units of Jedi1, a modification of OB1. Jedi1 would require the same manufacturing processes as OB1. Zhao Co. has offered to pay Toys for fun Co. $33 for a unit of Jedi1 and half the selling costs per unit.

1. Ottawa Co. has offered to produce 4,000 units of OB1 for Toys for fun Co. so that Toys for fun Co. may accept the Zhao Co. offer. That is, if Toys for fun Co. accepts the Ottawa Co. offer, Toys for fun Co. would manufacture 16,000 units of OB1 and 4,000 units of Jedi1 and purchase 4,000 units of OB1 from Ottawa Co. Ottawa Co. would charge Toys for fun Co. $30 per unit to manufacture OB1. Should Toys for fun Co. accept the Ottawa Co. offer? (Support your analysis with detailed analysis).

2. Suppose Toys for fun Co. had been working at less than full capacity, producing 16,000 units of OB1 at the time the Zhao Co. offer was made. What is the minimum price Toys for fun Co. should accept for Jedi1 under these conditions (ignore the previous $33 selling price).

Answer 1

1.

Scenario 1 - Producing 20,000 units of OB1 (not accepting the offer)

Scenario 2 - Producing 16,000 units of Ob1 and 4,000 units of Jedi, buying 4,00 units of OB1 from Ottawa.

Quantitative analysis of the two is as below:

We can see that it is more profitable for Toys for fun to accept the offer.

2.

Costs incurred while producing 16,000 units of OB1 and 4,000 units of Jedi

Variable Cost per unit= $31

Total Variable Cost = $620,000

Fixed Cost = $80,000

Total Cost = $700,000

Sale Value of OB1 = 16,000 x 40= $640,000

To break even, they need to have an additional $60,000 sales. Therefore, the minimum price that Toys for fun should charge for Jedi would be $60,000/4,000 = $15 per unit