Question

Company A produces two products—methanol (wood alcohol) and turpentine -- in a joint process. Joint costs amount to $125,000 per batch of output. Each batch totals 13,500 gallons, made of 25% methanol and 75% turpentine. Both products are processed further without gain or loss in volume. Separable processing costs are methanol, $11 per gallon; turpentine, $3 per gallon. Methanol sells for $22 per gallon. Turpentine sells for $16 per gallon.

The company has discovered an additional process by which the methanol (wood alcohol) can be made into a pleasant-tasting alcoholic beverage. The selling price of this beverage would be $42 a gallon. Additional processing would increase separable costs by $12 per gallon (in addition to the $11 per gallon separable cost required to yield methanol). The company would have to pay excise taxes of 20% on the selling price of the beverage.

Requirement: Under the following assumptions, calculate the gross margin (in total $) of the turpentine product.

1. The firm chooses its product mix to maximizes operating profit.
2. Joint cost is allocated on an NRV basis.
3. There are no beginning or ending inventories.

Answer 1

since the company wants to maximize operating profit, it will not produce the beverage

thus we allocate 125000 joint cost as % of nrv for only methanol and turpentine

Thus % of NRV for turpentine = 13/(11+13) = 54.16%

joint cost allocated to turpentine = 54.16% x 125000 = 67708.33

gallons of 75% of 13500 = 10125 gallons

NRV per gallon of turpentine.= $13

Therefore NRV from turpentine = $13 x 10125 = $131625

Gross profit = NRV - joint cost

Gross profit = 131625 - 67708.33 = $63916.67