Question

Case 3: Tackle Boxes or Skateboards Outsy Corporation is a wholesale distributor that supplies a wide-range of moderately priced sporting equipment to large chain stores. About 60 percent of Outsy’s products are purchased outside supliers; the remainder of the products are manufactured by Outsy. The company has a plastics department that currently manufactures molded fishing tackle boxes. Outsy is able to manufacture and sell 8,000 tackle boxes per year. At that production level, the company uses all its direct labor capacity at available workstations; workers are paid according to the number of boxes they make. However, no overtime is available, and, due special skills required to make the tackle boxes, no additional hours are available from other workers in the company. Exhibit 1 shows the selling price of and costs associated with the Outsy’s tackle boxes. John Beckwith, Outsy’s Chief Operating Officer, believes the company could sell as many as 12,000 tackle boxes if it had sufficient manufacturing capacity. Consequently, one of the alternatives the company has looked into is the possibility of purchasing the tackle boxes from another manufacturer. Rustle Products, a quality manufacturer of plastics products, has offered to provide as many tackle boxes per year as Outsy may need at a price of $68 per box. Jeremy Grey, Outsy’s product manager, has suggested that the company could make better use of its plastics department by manufacturing skateboards. To support his position, Jeremy has provided a market study that indicates an expanding market for skateboards and a need for additional suppliers. Jeremy believes that Outsy could expect to sell 17,500 skateboards annually at a price of $45 per skateboard. Jeremy’s estimate of the cost to manufacture the skateboards is presented in Exhibit 2. The company uses direct labor-hours as the cost driver to apply manufacturing overhead to production in the plastics department. Included in the manufacturing overhead for the current year is $50,000 of factory-wide, fixed manufacturing overhead. For each unit of product sold the company applies a $6 fixed distribution overhead charge regardless of whether the product has been purchased or manufactured in-house. This cost is included in the selling and administrative cost for all products. Total selling and administrative cost for the purchased tackle boxes would be $10 per unit. Required: Write a Memo to Mr. Beckwith with a recommendation indicating which of the above alternatives would result in the maximization of Outsy’s profitability and most efficient use of the plastics manufacturing capacity. Remember to highlight any qualitative factors that should be considered in the decision. Exhibit 1: Outsy Corporation Unit Selling Price and Cost of a Tackle Box Selling price per box $86.00 Cost per box: Molded plastic $ 8.00 Hinges, latches, & handle 9.00 Direct labor ($15 per hour) 18.75 Manufacturing overhead 12.50 Selling & administrative cost 17.00 Total cost per box $ 62.25 Profit per box $20.75 Exhibit 2: Outsy Corporation Unit Selling Price and Cost of a Skateboard Selling price per skateboard $45.00 Cost per skateboard: Molded plastic $ 5.50 Wheels and hardware 7.00 Direct labor ($15 per hour) 7.50 Manufacturing overhead 5.00 Selling & administrative cost 9.00 Total cost per skateboard $ 34.00 Profit per skateboard $11.00

Answer 1

As the overheads are uniformly being absorbed based on hours and units, they are fixed costs.

So, they shouldn't form part of your analysis for decision making

And from this consider only the variable Molded Plastic cost, Latch and Handle and Direct Labour for Tackle boxes

And for skate board, consider the molded plastic, wheels and hard ware and direct labour cost.

And only the purchase price for outsource option

Which gives

Tackle Box Contribution = 86 - 8 - 9 - 18.75 = $50.25 per unit

Skate boad Contribution = 45 - 5.5 - 7 - 7.5 = $25 per unit

Outsource Option Contribution = 86 - 68 = $18 per unit

Although it seems favourable for Tackle box, the main constraining factor or the bottleneck is direct labour hours, so we should consider CONTRIBUTION PER HOUR

Tackle Box CPH = 50.25/1.25 = $40.2 per Hour

Skate Board CPH = 25/0.5 = $50 per Hour

So this shows that the labour hours of the company should first be used to produce skateboards, then on tackle boxes and any additional demand of tackle boxes can be fulfilled by outsourcing.

We can sell 17,500 units of skateboards which require 8,750 hours of manpower or labour.

And the remaining 1,250 hours can utilised to produce tackle boxes. (10,000 - 8,750). Which can be used to produce 1000 units of tackle boxes. As we can sell 12,000 tackle boxes, the remaining 11,000 can be acquired through outsourcing option.

So the final contributions and profits would be,

Good luck