support your decision. (adapted from CMA Canada, now CPA Canada) (SO 3) Calculat
ID: 2543164 • Letter: S
Question
support your decision. (adapted from CMA Canada, now CPA Canada) (SO 3) Calculate the P7-43A The Kamloops Outdoors Corporation, which produces a highly successful line of summer lotions and insect repellents and sells them to wholesalers, has decided to diversify in order to stabilize its sales throughout the year. A natural area for the company to consider is the production of contribution margin and prepare winter lotions and creams to prevent dry and chapped skin. After considerable research, the company has developed a winter products line. However, because of the conserva- tive nature of company management, the president has decided to introduce only one of the new products for this coming incremental analysis for a make-or-buy decision. winter. If the product is a success, there will be further expansion in future years. The product selected is a lip balm to be sold in a lipstick-type tube. The company will sell the product to wholesalers in boxes of 24 tubes for $16.00 per box. Because of available capacity, the company will incur no additional fixed charges to produce the product. However, to allocate a fair share of the company's present fixed costs to the new product, the product will absorb a $150,000 fixed charge. Using the estimated sales and production of 100,000 boxes of lip balm as the standard volume, the accounting depart ment has developed the following costs per box of 24 tubes: Direct labour Direct materials Total overhead Total 4.00 6.00 3.00 $13.00 Kamloops Outdoors has approached a cosmetics manufacturer to discuss the possibility of the tubes for the new product. The purchase price of the empty tubes from the cosmetics manufacturer would be $1.90 per 24 tubes. If Kamloops Outdoors accepts the purchase proposal, it is estimated that direct labour and variable overhead costs would be reduced by 10% and direct materials costs would be reduced by 20%. Instructions Answer the following questions: (a) Should Kamloops Outdoors make or buy the tubes? Show calculations to support your answer. (b) What would be the maximum purchase price acceptable to Kamloops Outdoors for the tubes? Support your answer (b) $1.75 with an explanation. (e) $8,750 (e) Instead of sales of 100,000 boxes, revised estimates show a sales volume of 125,000 boxes. At this new volume,the com- pany must acquire additional equipment, at an annual rental charge of $10,000, to manufacture the tubes. However this incremental cost would be the only level is the goal for the third year of the tubes? Show calculations to support your answer additional fixed cost, even if sales to 300,000 boxes. (The 300,000 Under these circumstances, should Kamloops Outdoors make or buy (d) The company has the option of making and buying at the same time. What would be your answer to ? Show calculations to support your answer. alternative was c (e) What qualitative factors should Kamloops Outdoors Corporation consider in determining whether it should make or (adapted from CMA Canada, now CPA Canada) buy the lip balm tubes?Explanation / Answer
Solution to Question A
Calculation of variable overhead
Total overheads per box
3
No. of boxes
1,00,000
Total overheads
3,00,000
Allocation of fixed overheads
-1,50,000
Total variable overheads
1,50,000
Variable overhead per box
1.50
Total cost saving on purchase of tubes
Cost per unit
Saving
Total saving
Direct labour
4
10%
0.40
Direct material
6
20%
1.20
Direct overhead
2
10%
0.15
Total saving
1.75
Total cost saving per box is USD 1.75. Purchase price is USD 1.9
Therefore, the company should not purchase tubes but manufacture internally
Solution to Question B
Based on the above calculation, the maximum purchase price for tubes should be USD 1.75
Response to Question C
In case of increase in volume to 125,000 units
Assuming 125,000 tubes are purchased, total cost will be
2,37,500
Assuming 125,000 tubes are manufactures
Manufacturing cost (1.75*125,000)
2,15,000
Additional cost to rent the machine
10,000
Total Cost
2,25,000
Therefore, even if the volume increases to 125,000 units, the company
should incure the additional rent but still manufacture the tubes
Considering that there is no incremental rental cost till further capacity
of 300,000 units, this will further benefit the company in the third year
as the average cost of tubes will further reduce, as the capacity utilised
increases
Response to Question D
In case the company has an option to buy as well as manufacture, the
company should still manufacture, as the incremental csot of
manufacture is less than the purchase price offered in the market
Response to Question E
Qualitative factors may include
- Quality of raw material used by the vendor
- Timely delivery of material
- Consistency in quality of final product
- Future price change potential
- Abrupt stoppage of supply by the vendor
- Flexibility in accomodating production schedule of the company
- Meeting any urgent requirements/delaying delivery in case company requires
- Minimum commitment quantity to be ordered to the vendor
Solution to Question A
Calculation of variable overhead
Total overheads per box
3
No. of boxes
1,00,000
Total overheads
3,00,000
Allocation of fixed overheads
-1,50,000
Total variable overheads
1,50,000
Variable overhead per box
1.50
Total cost saving on purchase of tubes
Cost per unit
Saving
Total saving
Direct labour
4
10%
0.40
Direct material
6
20%
1.20
Direct overhead
2
10%
0.15
Total saving
1.75
Total cost saving per box is USD 1.75. Purchase price is USD 1.9
Therefore, the company should not purchase tubes but manufacture internally
Solution to Question B
Based on the above calculation, the maximum purchase price for tubes should be USD 1.75
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