Question

Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However, Silven’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.

The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $11 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $94,500 charge for fixed manufacturing overhead will be absorbed by the product under the company’s absorption costing system.

Using the estimated sales and production of 105,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box:

Direct material	$	4.80
Direct labor		3.20
Manufacturing overhead		2.00
Total cost	$	10.00

The costs above relate to making both the lip balm and the tube that contains it. As an alternative to making the tubes for Chap-Off, Silven has approached a supplier to discuss the possibility of buying the tubes. The purchase price of the supplier's empty tubes would be $2.00 per box of 24 tubes. If Silven Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 30%.

Required:

1. If Silven buys its tubes from the outside supplier, how much of its own Chap-Off manufacturing costs per box will it be able to avoid? (Hint: You need to separate the manufacturing overhead of $2.00 per box that is shown above into its variable and fixed components to derive the correct answer.)

2. What is the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier?

3. What is the financial advantage (disadvantage) in total (not per box) if Silven buys 105,000 boxes of tubes from the outside supplier?

4. Should Silven Industries make or buy the tubes?

5. What is the maximum price that Silven should be willing to pay the outside supplier for a box of 24 tubes?

6. Instead of sales of 105,000 boxes of tubes, revised estimates show a sales volume of 131,000 boxes of tubes. At this higher sales volume, Silven would need to rent extra equipment at a cost of $46,000 per year to make the additional 26,000 boxes of tubes. Assuming that the outside supplier will not accept an order for less than 131,000 boxes of tubes, what is the financial advantage (disadvantage) in total (not per box) if Silven buys 131,000 boxes of tubes from the outside supplier? Given this new information, should Silven Industries make or buy the tubes?

7. Refer to the data in (6) above. Assume that the outside supplier will accept an order of any size for the tubes at a price of $2.00 per box. How many boxes of tubes should Silven make? How many boxes of tubes should it buy from the outside supplier?

Answer 1

It is given that because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. It is given that $94500 charge for manufacturing overhead will be absorbed by the product.

Estimated sales and production is 105000 boxes.

Therefore fixed manufacturing overhead per box = 94500/105000 = $0.9

Manufacturing overhead per box is given as $2.

Therefore variable manufacturing overhead = 2-0.9 = $1.1

The purchase price of the supplier's empty tubes would be $2.00 per box of 24 tubes. If Silven Industries stops making the tubes and buys them from the outside supplier, its direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and its direct materials costs would be reduced by 30%.

	If manufacture both lip balm and tube	Savings in manufacturing cost if tube is purchased from outside
Direct material	4.8	30%	1.44
Direct labor	3.2	10%	0.32
Variable manufacturing overhead	1.1	10%	0.11
Total cost	9.1	Savings:	1.87

Therefore, if Silven buys its tubes from the outside supplier, it will be able to avoid $1.87 of manufacturing cost per box.

2.

Statement showing the financial advantage (disadvantage) per box of Chap-Off if Silven buys its tubes from the outside supplier
A. Savings in manufacturing cost per box if purchased outside	$1.87
B. Purchase price of empty tube per box	$2
C. Financial disadvantage per box =B-A	$0.13

3.

Statement showing financial advantage (disadvantage) in total (not per box) if Silven buys 105,000 boxes of tubes from the outside supplier
A. Number of boxes	105000
B. Financial disadvantage per box	$0.13
C. Total Financial disadvantage = A*B	$13,650.00

4.

As there is a financial disadvantage of $13650 if it purchases from outside, it is better to make the tubes inhouse.

5.

The maximum price that Silven should be willing to pay the outside supplier for a box is the amount it is saving in manufacturing cost per box i.e. $1.87

6.

Revised sales volume is 131000 boxes.

Rent of extra equipment is $46000 per year to make the additional 26000 boxes.

Now, the total cost savings if purchased from outside is $1.87 per box plus $46000.

= (131000 boxes*$1.87)+$46000

=290970

Total purchase cost if purchased from outside @$2 per box = 131000*2 = $262000

It is given that the outside supplier will not accept an order for less than 131000 boxes.

Statement showing financial advantage (disadvantage) in total (not per box) if Silven buys 131,000 boxes of tubes from the outside supplier
A. Total Savings in manufacturing cost if purchased outside	$290,970.00
B. Total Purchase cost of empty tubes	$262,000.00
C. Total financial advantage of purchasing outside= A-B	$28,970.00

Given this new information, Silven Industries should buy the tubes as there is a financial advantage of $28,970.00.

7.

It is given that the outside supplier will accept an order of any size for the tubes.

Upto 105000 boxes, there is no need to rent the extra equipment if we make inhouse.

For the 26000 additional boxed we need to incur $46000 towards rent of extra equipment.

Upto 105000 boxes, cost saving are only $1.87 per box where as the purchase cost is $2 from outside supplier. So, we can MAKE 105000 boxes inhouse.

For rest 26000 boxes, total savings in manufacturing cost if tubes are purchased from outside is $1.87 per box plus rent of $46000 = $94620.

Purchase cost of 26000 boxes from outside supplier = 26000boxes * $2 = 52000

Financial advantage of purchasing 26000 boxes from outside supplier= 94620-52000 = $42,620.00

As savings in manufacturing cost are more if we purchase from outside supplier, it is advisable to BUY 26000 boxes from outside supplier.

Summary:
Boxes to be manufactured inhouse(MAKE)	105000 boxes
Boxes to be purchased from outside(BUY)	26000 boxes
Total	131000 boxes