Question

3 Problem 12-23 Make or Buy Decision (L012-3) 12 points eBook 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: Print References Direct material Direct labor Manufacturing overhead Total cost $ 4.80 3.20 2.00 $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-Offif Silven buys its tubes from the outside supplier? the financial advantage (disadvantage) in total (not per box) ir Silver buys 105,000 boxes of tubes from the outside supplier?

Answer 1

First, let us segregate fixed overhead from total overhead

Fixed overhead = 94,500 / 105,000 = 0.90 per box

1.

Particulars	Before reduction	Reduction	After reduction	Avoidable
Direct Materials	$ 4.80	30%	$ 3.36	$ 1.44
Direct Labor	$ 3.20	10%	$ 2.88	$ 0.32
Manufacturing Overhead	$ 1.10	10%	$ 0.99	$ 0.11
Purchase price	$ 2.00		$ 2.00
Total			$ 9.23	$ 1.87

2

Financial DISADVANTAGE is 0.13 per box in case it is bought from outside supplier

3

Financial DISADVANTAGE is 0.13 X 105,000 = 13,650

4

MAKE because it is cheaper

5

Maximum price that Silven should be willing to pay = Savings in cost = 1.87 per box

6

Cost of making = 131,000 X 9.1 + 46,000 = 1,238,100
Buying = 131,000 X 9.23 = 1,209,130

Financial ADVANTAGE of buying = 28,970

7

Make 105000, Buy 26000