Question

Question 1

CV Pte Ltd manufactures electronic calculators. Currently, CV purchases the special chip used to manufacture its products from an outside supplier. The supplier charges CV $8 per chip. CV’s CEO is considering a proposal to purchase either machine A or machine B so that the company can manufacture its own chips. In addition, the outside supplier has informed CV that they will increase current prices by $2 per chip. The projected data on the two machines are as follows:

	Machine A	Machine B
Annual fixed cost	$740,000	$1,056,000
Variable cost per chip	$2.60	$1.20

Required:

1. For each machine, what is the minimum number of chips that CV must manufacture annually for total costs to be equal to the cost of purchasing from outside supplier?

(4 marks)

2. At what production volume would it cost CV the same total costs regardless of which machine is purchased?

(5 marks)

3. Which is the most profitable alternative if CV required 240,000 chips per year? Support your answer with relevant computations.

(6 marks)

4. Propose which alternative you would recommend the CEO of CV to choose. Explain your recommendation clearly.

(7 marks)

5. List three (3) qualitative issues CV should consider when deciding whether to continue buying the chips or start producing the chips internally.

(6 marks)

Answer 1

a.
Machine A
Costs to cover = $10 - $2.60 = $7.40 per chip
Minimum number of chips for Machine A = $740000 / 7.40 = 100000 chips

Machine B
Costs to cover = $10 - $1.20 = $8.80 per chip
Minimum number of chips for Machine A = $1056000 / 8.80 = 120000 chips

b.
Production Volume = Difference in fixed costs / difference in variable costs
= ($1056000-740000)/(2.60-1.20) = 225715 chips

c.
Machine B should be chosen, since it has lower variable cost, and after 225715 chips Machine B will be more beneficial

	Machine A	Machine B	Purchase
Fixed Cost	$           7,40,000	$         10,56,000
Variable Cost	$           6,24,000	$           2,88,000
Purchase cost			$           24,00,000
Total Cost	$        13,64,000	$        13,44,000	$          24,00,000

Machine B has lowest total cost

d.
It depends on number of chips required.
If chips are required less than 100000, then they should be purchased from outside supplier, but if they require more then 100000 chips, then purchase option should not be considered. This is also calculated in part a.

If chips are required less than 225715 chips, then Machine A should be considered since costs for 225715 chips will be same, and fixed costs is lower for Machine A

If chips are required more than 225715 chips, then Machine B should be considered since costs for 225715 chips will be same and variable cost is lower for Machine B

e.
Quality of product delivered
Timing of delivery i.e. whether demand can be met at time
Consistent Quality for any quantity