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 16 tubes for $6.60 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $120,000 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 100,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box:

Direct materials $2.80

Direct labor $1.00

Manufacturing overhead $1.60

Total cost $5.40

The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be $0.80 per box of 16 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 20%.

Required:

1a. Calculate the total variable cost of producing one box of Chap-Off? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Total variable cost = ________________per box

1b. Assume that the tubes for the Chap-Off are purchased from the outside supplier, calculate the total variable cost of producing one box of Chap-Off? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Total variable cost = ________________per box

1c. Should Silven Industries make or buy the tubes?

Answer 1

1a. Total Variable Cost of producing one box of Chap-off :

Direct Material = $2.80

Direct Labour = $1.00

Manufacturing Overhead = $ 0.40 [1.60 - (120000/100000)]

Total Variable Cost = $ 4.20

1b. Total Variable Cost of producing one box of Chap-off if tubes for the Chap-off are purchased from outside supplier:

Direct Material = $2.24 [2.80 - (2.80*0.20)]

Direct Labour = $0.90 [1.00 - (1.00*0.10)]

Manufacturing Overhead = $ 0.36 [0.40 - (0.40*0.10)]

Price of empty tubes = $0.80

Total Variable cost = $4.30

1c. From the above we can see that the total variable cost is more if we buy empty tubes from outside supplier. Hence, Silven Industries should make the tubes on its own.