Decision Making 63g18

Question –1 In my opinion we ought to stop making our own drums and accept that outside supplier’s offer, said managing director of Antilles refining at a price of Tk. 18 per drum. We would be paying Tk.5 less than it cost us to manufacture the drums in our own plant. Since we use 60000 drums a year, that would be an annual cost savings of Tk.300000. Antilles refining present cost to manufacture one drum is given below (based on 60000 drums per year). Direct Material Direct Labour

Tk. 10.35 6

Variable overhead

1.50

Fixed Overhead(Tk.2.80 general company overheads, Tk.1.60 depreciation and Tk. 0.75 supervision

5.15

Total cost per drum

Tk. 23.00

A decision about whether to make or buy the drums is specially important at this time since the equipment being used to make the drums is completely worn out and must be replaced. The choice facing the company are: Alternative 1: Purchase new equipment and continue to make the drums. The equipment would cost Tk. 810000; it would have six year useful life and no salvage value. The company use straight line depreciation. Alternative 2: Purchase the drums from an outside supplier at Tk.18 per drum under a six year contract.

The new equipment would be more efficient than the equipment that Antilles Refining has been using and, according to the manufacturer, would reduce direct labour and variable overhead cost by 30%. The old equipment has no resale value. Supervision cost (Tk.45000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipments capacity would be 90,000 drums per year. The company has no other use for the space being used to produce the drums. The company’s total general company overhead would be unaffected by this decision.

Answers: The Tk. 2.80 per drum general overhead cost is not relevant to the decision. Since this cost will be the same regard;less of whether the company decides to make or buy the drums. Also, the present depreciation figure of Tk.1.60 per drum is not a relevant cost. Since3 it represents a sunk cost( in addition to the fact that the old equipment is worn out and must be replaced). The cost (depreciation) of the new equipment is a relevant cost, since the new equipment will not be purchased if the company decides to accept the outside suppliers offer. The cost of supervision is relevant to the decision, since this cost can be avoided by buying the drums. Tk.810000/ 6=Tk.135000 per year Tk.135000 per year/60000 drums=Tk.2.25 per drum Differential cost per Drum

Total differential cost –60000 drums

Make

Make

Buy

Outside supplier price Direct Materials

Buy

18

1080000

10.35

621000

Direct Labor 6x70%

4.20

252000

Variable overhead1.5x70%

1.05

63000

Supervision

0.75

45000

Depreciation

2.25

135000

Total cost Difference in favor of buying

18.60 0.60

18.00

1116000 36000

1080000

Queswtion –2 :The waltonn toy company manufactures a line of dolls and a doll dress sewing kit. Demand for the dolls is increasing. And management request assistance from you in determining an economical sales and production mix for the coming year. The company’s sales department provides the following information.

Product

Estimated Demand Selling price per unit

Debbie

50000

13.5

Trish

42000

5.50

Sarah

35000

21

Mike

40000

10

325000

8

Sewing Kit

The standard cost for direct materials and direct labour per unit are as follows: Product

Direct Material

Direct labour

Debbie

4.30

3.20

Trish

1.10

2

Sarah

6.44

5.60

2

4

3.20

1.60

Mike Sewing Kit

The following additional information's are available: a. The company’s plants has a capacity of 130000 direct labor hours per year on a single shift basis. The company’s present employees and equipment can produce all five products. b. The direct labor rate is Tk.8 per hour this rate is expected to remain unchanged during the coming year. c. Fixed cost total Tk.520000 per year. Variable overhead costs are Tk. 2 per direct labor hour. d. All of the company’s manufacturing cost are fixed. e. The company’s present inventory of finished goods is negligible and can be ignored. Required: a. Determine the contribution margin per direct labor hour expended on each product. b. Prepare schedule showing the total direct labor hours that will be required to produce the units estimated to be sold during the coming year. c. Examine the data you have computed in a and b above. Indicate how much of each product should be made so that total production time is equal to the 130000 hours available. d. What is the highest price, in of rate per hour, that walton toy company would be willing to pay for additional capacity (that is for added direct labor time)? e. Assume again that the company does not want to reduce sales of any product. Identify ways in which the company could obtain the additional output?

1. Debbie Direct labor cost per unit

Trish

Sarah

Mike

Sewing Kit

3.20

2.00

5.60

4.00

1.60

0.40 hrs

0.25hrs

0.70hrs

0.50hrs

0.20hrs

13.50

5.50

21.00

1.00

8.00

Direct materials

4.30

1.10

6.44

2.00

3.20

Direct labor

3.20

2.00

5.60

4.00

1.60

Variable overhead

0.80

0.50

1.40

1.00

0.40

Total variable cost

8.30

3.60

13.44

7.00

5.20

Contribution margin (b)

5.20

1.90

7.56

3.00

2.80

13.00

7.60

10.80

6.00

14.00

Direct labor hours per unit -a Selling price Less:Variable costs:

Contribution margin (b) / (a)

Calculation for a: Direct labour cost per unit/Tk.8 per direct labour hour

2. Product

DLH per unit

Estimated sales (units)

Total hours

Debbies

0.40

50000

20000

Trish

0.25

42000

10500

Sarah

0.70

35000

24500

Mike

0.50

40000

20000

Sewing Kit

0.20

325000

65000

Total hours required

140000

3. Since the Mike doll provides the lowest contribution margin per labor hour, its production should be reduced by 20000 dolls (10000 excess hours divided by 0.5 hrs production time per doll =20000 dolls). Thus production and sales of the Mike doll will be reduced to one-half of the planned or 20000 dolls for the year. 4. Since the additional capacity would be used to produce the Mike doll, the company should be willing to pay up to Tk.14 per hour (Tk.8 usual rate plus Tk.6 contribution margin per hour) for added labor time. Thus, the company could employ workers for overtime at the usual time and a half rate of Tk.12 per hour (Tk8x1.5=12), and still improve overall profit. 5. Additional output could be obtained in a number of ways including working overtime, adding another shift, expanding the workforce, contracting out some work to outside suppliers, and eliminating wasted labor time in the production process. The first four methods are costly, but the last method can add capacity at very low cost. Note: Some would argue that direct labor is a fixed cost in this situation and should be excluded when computing the contribution margin per unit. However, when deciding which products to emphasize, no harm is done by misclassifying a fixed cost as a variable cost- providing that the fixed cost is the constant. If direct labor were removed from the variable cost category, the net effect would be to bump up the contribution margin per direct labor hour by Tk.8 for each of the products. The products will be ranked exactly the same – interims of the contribution margin per unit of the constrained resources- whether direct labor is considered variable or fixed.