Silven Industries, which manufactures and sells a highly successful line of summ

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 w 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 12 tubes for $8.50 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $110,000 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 Direct labor Manufacturing overhead $4.80 1.00 1.40 otal cost $7.20 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 $1.20 per box of 12 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%.

Explanation / Answer

Answer

Fixed manufacturing cost to be absorbed

$110000

No. of boxes

100000

Fixed manufacturing overhead per box

$1.1

Manufacturing overhead per box (given)

$1.4

(-) Fixed manufacturing overhead per box

$1.1

Variable manufacturing overhead per box

$0.3

Direct materials

$4.8

Direct Labor

$1

Variable Manufacturing Overhead

$0.3

Total Variable cost

$6.1 per box

Purchase cost

$1.2

Direct Materials [4.8-20%]

$3.84

Direct Labor [1-10%]

$0.9

Variable Manufacturing Overhead [0.3-10%]

$0.27

Total Variable cost

$6.21

Since, the variable cost to purchase ($6.21) is more than variable cost of producing ($6.1), Silven Industries should MAKE the tubes.

Maximum purchase price would be such that the total variable cost if purchased should not exceed $6.1 per box. Hence, maximum purchase price would be $6.1 - $(3.84-0.9-0.27) = $1.09 per box

Proof:

Purchase cost

$1.09

Direct Materials

$3.84

Direct Labor

$0.9

Variable Manufacturing Overhead

$0.27

Total Variable cost

$6.1

Fixed manufacturing cost to be absorbed

$110000

No. of boxes

100000

Fixed manufacturing overhead per box

$1.1

Manufacturing overhead per box (given)

$1.4

(-) Fixed manufacturing overhead per box

$1.1

Variable manufacturing overhead per box

$0.3

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