Question

Cantel Company produces cleaning compounds for both commercial and household customers. Some of these products are produced as part of a joint manufacturing process. For example, GR37, a coarse cleaning powder meant for commercial sale, costs $2.30 a pound to make and sells for $2.40 per pound. A portion of the annual production of GR37 is retained for further processing in a separate department where it is combined with several other ingredients to form SilPol, which is sold as a silver polish, at $4.00 per unit. The additional processing requires 1/4 pound of GR37 per unit; additional processing costs amount to $2.80 per unit of SilPol produced. Variable selling costs for SilPol average $0.30 per unit. If production of SilPol were discontinued, $3,000 of costs in the processing department would be avoided. Cantel has, at this point, unlimited demand for, but limited capacity to produce, product GR37.

Required

1. Calculate the minimum number of units of SilPol that would have to be sold in order to justify further processing of GR37.

2. Assume that the cost data reported for GR37 are obtained at a level of output equal to 5,300 pounds, which is the maximum that the company can produce at this time. What is the expected operating income (loss) under each of the following scenarios: (a) all available capacity is used to produce GR37, but no SilPol; (b) 7,500 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37; (c) 10,000 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37; and (d) 12,000 units of SilPol are produced, with the balance of capacity devoted to the production and sale of GR37.

Answer 1

1. Contribution Margin per Unit = Selling Price of Silver Polish - Additional Processing Cost - Revenue Lost on GR37 - Variable Selling Cost

= $4.00-2.80-(2.4/4)-0.30

= $0.30

Minimum number of units to justify further processing = 3,000/0.3

= 10,000 units

2. Income = 5,300*(2.4-2.3) = $530

GR37 consumed in 7,500 units of SilPol = 7,500/4 = 1,875 pounds

Operating income = (4-2.8-0.3)*7,500 – 3,000 + 2.4*3,425 – 2.3*5,300 = -$220

GR37 consumed in 10,000 units of SilPol = 10,000/4 = 2,500 pounds

Operating income = (4-2.8-0.3)*10,000 – 3,000 + 2.4*2,800 – 2.3*5,300

= $530

GR37 consumed in 12,000 units of SilPol = 12,000/4 = 3,000 pounds

Operating income = (4-2.8-0.3)*12,000 – 3,000 + 2.4*2,300 – 2.3*5,300 = $1,130