A corporation wants to manufacture mighty mint to sell to wholesalers in package

Question

A corporation wants to manufacture mighty mint to sell to wholesalers in packages of 30 for $18 per package. Mgmt. allocates $200,000 of fixed manufactoring overhead costs to mighty mint. The manufactoring cost per package of 30 containers for expected production of 100,000 packages is: direct material=$6.50, direct labor=$3.50, Overhead=$3.00, TOTAL=$13.00
The company contacted suppliers to determine is it better to buy or manufacture the containers. The lowest quote for containers is $1.75 per 30 units. Purchasing the containers from a supplier will save 10% of direct materials, 20% of direct labor and 15% of overhead. By purchasing containers the company will have to lease space at cost of $15,00o per year. If containers are purchased, one supervisor position of $70,000 a year will be eliminated. SHOULD THEY BUY OR MAKE THE CONTAINERS? WHAT IS THE INCREMENTAL COST (BENEFIT) OF BUYING THE CONTAINERS AS OPPOSED TO MAKING THEM?

Explanation / Answer

buying empty containers from outside or to manufacture the containers

Fixed overhead per package is = Total Fixed OH/Total packages = $200,000/100,000 = $2 per package
As Total overhead is $3 which includes fixed and variable OH, we know that variable OH = $3-$2=$1per package

Option : Buy 30 Empty container (1 package) at $1.75 for 30 units.
This will save :-
10% of Direct material   =   10%*$6.50 = $0.65
20% of Direct labor        =   20%*$3.50 = $0.70
15% of variable OH     =   15%*$1.00 = $0.15

                                                                     $1.50
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Total saving per package = $1.50
But Buy cost per package is $1.75

SO net expense of Buy decision is $1.50-$1.75 = $0.25 per package
SO for 100,000 packages, Additional expense will be $0.25*100,000 = $25,000.........................................................................................................................(A)

Saving due to Buy decison is :-

Leasing cost saving $15,000
Supervisor salary     $70,000

                                $85,000

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Total Saving $85,000………………………………………………………….….......(B)
So Saving Due to Buy decision = B-A = $85,000-$25,000 = $60,000.........................(C)

Now lets look at Revenues :-

1. If we don't buy, Cost per unit = Sale price per unit - Var cost per unit = $18- (6.5+3.5+1.0) = $7 per unit

So for 100,000 packages, Total Cost = $7*100,000 = $700,000
Less Fixed OH $200,000 gives Gross Income = $500,000( 700000-200000 ).............(D)

2. If we Buy, Cost per unit = $18-[(6.5-0.65)+(3.5-0.70)+(1.0-0.15)]-$1.75 = $6.75pu
So for 100,000 packages, Total Cost = $6.75*100,000 = $675,000
Less Fixed OH $200,000 gives Gross Income = $475,000( 675000-200000 )
Add : Saving due to Buy decision ( C above) = $60,000
SO Gross Income = $535,000.......................................................................................(E)

----So Curtis should Buy the containers as it is giving an Additional Income (See above D &E) of 535000-500000 = $35,000

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