Question

McVay Industries (MI) produces ice cream supplies including bowls, scoops and shake makers. MI made $605,000 of pre-tax profit last year.  They are looking for ways to improve profitability and are considering outsourcing production of their Bowls. Juan Hernandez, the controller, compiled the following information.

	Bowls		Scoops		Shake Makers		TOTAL
Units Manufactured and sold	2,000,000		500,000		100,000
DM per unit	$0.50		$1.25		$5.00
DL per unit	$0.10		$0.50		$4.00
VMOH per unit	$0.15		$0.25		$5.00
FMOH per unit (based on current production)	$0.40		$0.50		$5.00
Total Cost per unit	$1.15		$2.50		$19.00
Selling Price	$2.00		$4.00		$25.00
Gross Profit per Unit	$0.85		$1.50		$6.00
Total Sales	$4,000,000		$2,000,000		$2,500,000		$8,500,000
Total COGS	$2,300,000		$1,250,000		$1,900,000		$5,450,000
Total Gross Profit	$1,700,000		$750,000		$600,000		$3,050,000
Total Variable (selling) costs	($300,000)		($100,000)		($125,000)		($525,000)
SG&A Fixed Costs – Direct*	($400,000)		($200,000)		($100,000)		($700,000)
SG&A Fixed Costs – Common**	($680,000)		($300,000)		($240,000)		($1,220,000)
Pre-Tax Profit	$320,000		$150,000		$135,000		$605,000

*   Direct SG&A Fixed Costs can be eliminated if the specific product is outsourced.

** Common  SG&A Fixed Costs can not be eliminated even if the specific product is outsourced.

If the bowls are outsourced, fixed manufacturing overhead costs of $366,500 to lease machinery related to bowls production could be eliminated.  Assume that direct fixed SG&A expenses relate directly to the bowls line and could be completely eliminated if the bowls product line is dropped.

Additionally, if the bowls are outsourced, the company would have excess capacity and could produce and sell additional 20,000 scoops (for the same selling price of $4 per scoop), and additional 10,000 shake makers (for the same selling price of $25 per shake maker).  

Question: What is the maximum amount MI should pay for the bowl from an independent supplier (price per unit) to be no worse off financially? Show your work. Round your answer to two decimals.

Answer 1

Maximum price = Savings in cost by not making bowls + Benefits from selling additional Scoops + Benefits from selling additional Shake Makers

Savings in cost by not making bowls = [(DM + DL + VMOH) * Number of Units] + Savings in Fixed MOH + Direct SG & A Fixed Costs

= [($0.50 + $0.10 + $0.15) * 2,000,000 units) + $366,500 + $400,000

= $2,266,500

Benefit from selling 20,000 Scoops = (Revenue - Variable cost per unit) * 20,000 units

= ($4 - ($1.25 + $0.50 + 0.25 + Variable Selling Cost)) * 20,000 units

= [$4 - ($2 + ($100,000 / 500,000 units))] * 20,000 units

= ($4 - $2.20) * 20,000 units

= $36,000

Benefit from selling 10,000 Shake Makers = Revenue - Variable cost per unit) * 10,000 units

= ($25 - ($5 + $4 + $5 + Variable selling cost)) * 10,000 units

= ($25 - ($14 + ($125,000 / 100,000 units))) * 10,000 units

= ($25 - $15.25) * 10,000 units

= $97,500

Maximum Amount willing to pay = Savings in cost by not making bowls + Benefits from selling additional Scoops + Benefits from selling additional Shake Makers

= $2,266,500 + $36,000 + $97,500

= $2,400,000

Price per unit of Bowl = Maximum amount willing to pay / Number of units of bowls

= $2,400,000 / 2,000,000 units

= $1.2 per unit of bowl