Henry Horticultural, Ltd., is a leading producer of greenhouse irrigation system
ID: 2492640 • Letter: H
Question
Henry Horticultural, Ltd., is a leading producer of greenhouse irrigation systems. Currently, the company manufactures the timer unit used in each of its systems. Based on an annual production of 40,600 timers, the company has calculated the following unit costs. Direct fixed costs include supervisory and clerical salaries and equipment depreciation.
Talbert Time Pieces has offered to provide the timer units to Henry at a price of $34 per unit. If Henry accepts the offer, the current timer unit supervisory and clerical staff will be laid off.
Assume that if Henry Horticultural accepts Talbert’s offer, the company can use the freed-up manufacturing facilities to manufacture a new line of growing lights. The company estimates it can sell 86,490 of the new lights each year at a price of $11. Variable costs of the lights are expected to be $8 per unit. The timer unit supervisory and clerical staff would be transferred to this new product line. Calculate the total relevant cost to make the timer units and the net cost if they accept Talbert's offer.
Explanation / Answer
(b1)
Contribution margin per unit of new lights = Selling price – Variable cost = $11 - $8 = $3 per unit
Total Contribution margin from new lights = $3 * 86,490 = $259,470
The salaries cost shall be incurred for lights even if the timer unit is not manufactured. Hence, Salaries cost is irrelevant cost. Also, depreciation is irrelevant because it shall be incurred irrespective of the decision.
Make
Buy
Direct materials
$ 11.00
Direct labor
$ 6.00
Variable overhead
$ 3.00
Relevant cost per unit to make
$ 20.00
Cost to buy
$ 34.00
Units needed
40,600
40,600
Total relevant cost
$ 812,000.00
$ 1,380,400.00
Contribution margin of new lights
$ 0.00
-$ 259,470.00
Net relevant cost
$ 812,000.00
$ 1,120,930.00
It if not beneficial to accept the offer because the cost to make the timer units is less than cost of buy it from outside even after considering the benefits of using the facilities for alternative purpose.
Make
Buy
Direct materials
$ 11.00
Direct labor
$ 6.00
Variable overhead
$ 3.00
Relevant cost per unit to make
$ 20.00
Cost to buy
$ 34.00
Units needed
40,600
40,600
Total relevant cost
$ 812,000.00
$ 1,380,400.00
Contribution margin of new lights
$ 0.00
-$ 259,470.00
Net relevant cost
$ 812,000.00
$ 1,120,930.00
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