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DECISION RULE
Lovell should drop the digital watch segment only if its
profit would increase. This would only happen if the
fixed cost savings exceed the lost contribution
margin.
Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of special equip. 3
Supervisor's salary 2
General factory overhead 10
Unit product cost $ 30
The Make or Buy Decision
Direct materials $ 9
Direct labor 5
Variable overhead 1
Depreciation of equip. 3
Supervisor's salary 2
General factory overhead 10 -
Total cost $ 30 $ - $ -
Problem – Berta Inc. is a manufacturer of quality mattresses with an annual production and
sales of 10,000 units. Berta currently makes it own spring assemblies but has received an
offer from a supplier to furnish the springs for $48. Berta’s costs of production are as
follows:
30% of the fixed overhead is traceable to the spring assemblies and the rest is general
overhead that is allocated to each unit.
1. Suppose the company has no alternative use for and cannot rent out the production space
used for making the springs. Should it outsource the springs?
2. Suppose the company can use the production space for springs as a warehouse, replacing
the warehouse it currently rents for $180,000. Should it outsource the springs?
Decision To Make/Buy An Input
Note: In the decision making problems that follow we will ignore: (1) all factors not
explicitly given in the problem, (2) the time value of money
Problem – Vince Pasta Inc. makes a fancy variety of fresh pasta which it sells for $3/lb.
Vince currently uses 50% of its capacity, producing 150,000 pounds of pasta annually. Vince
recently received an offer from a chain restaurant to supply 100,000 pounds of pasta at $2.20
per pound. Vince budgeted production costs at 150,000 and 250,000 pounds are as follows:
The company does not expect to receive any additional orders in the near future. The sales
manager wants Vince to accept the order but the production manager does not. The
production manager argues that the order would cause a loss of $0.20 per pound. Should
Vince accept the special order?
Accept or Reject Special Order
Incremental Approach:
Status quo: making 150,000 lb. egg noodles
New project/activity: special order to make
100,000 lb. of additional noodles.
Incremental benefits:
Incremental costs:
Additional DM
Additional DL
Additional VOH
Total:
Accept or Reject Special Order
If Vince had a maximum capacity of 200,000 lb., should it accept the special
order? Assume this is an all or nothing order; Vince either provides all of the
100,000 pounds or none.
Note that now we have opportunity costs. The opportunity costs are the
benefits forgone from not selling 50,000 lb. to regular customers.
Incremental Approach:
Status quo: making 150,000 lb. egg noodles
New project/activity: special order to make 100,000 lb. of additional
noodles.
Incremental benefits:
increase in revenue:
Incremental costs:
Additional DM
Additional DL
Additional VOH
Opportunity costs of 50,000 lb.
Total:
Utilization of a Constrained Resource
Key Terms and Concepts
Product
1 2
Selling price per unit $ 60 $ 50
Less variable expenses per unit 36 35
Contribution margin per unit $ 24 $ 15
Current demand per week (units) 2,000 2,200
Contribution margin ratio 40% 30%
Processing time required
on machine A1 per unit 1.00 min. 0.50 min.
Utilization of a Constrained Resource
An Example
Product
1 2
Contribution margin per unit $ 24 $ 15
Time required to produce one unit ÷ min. ÷ min.
Contribution margin per minute
Utilization of a Constrained Resource
An Example
This is the
split-off point Get $8,000
Joint Products – Sell or Process further
This is the
split-off point Get $8,000
Joint Products – Sell or Process further
Problem – Bass Chemicals Inc. produces three chemicals: Acetox, Denox, and Pectix through
one joint process costing $80,000. These chemicals can all be sold at the split-off point or
processed further and sold at a higher price.
Sales value at Additional costs of Sales value
split-off point processing further if processed further
Acetox $50,000 $23,000 $65,000
Denox $25,000 $44,000 $82,000
Pectix $85,000 $93,000 $184,000
Which of the products should be processed further and which ones should be sold at the split
of point?
If the joint processing costs were $120,000, would you change your answer?