Problem 12-23 Make or Buy Decision [LO12-3] Silven Industries, which manufacture
ID: 2528398 • Letter: P
Question
Problem 12-23 Make or Buy Decision [LO12-3] 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 $10 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $115,500 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 165,000 boxes of Chap-Off, the Accounting Department has developed the following manufacturing cost per box: Direct material Direct labor Manufacturing overhead Total cost $4.70 3.00 2.10 $9.80 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%.Explanation / Answer
1) Calculation of cost it will be able to avoid by purchasing empty tubes from outside supplier:-
Working Note:- Separation of Manufacturing Overhead into Fixed and Variable
Total Fixed Overhead absorbed for this product given in the question = $115,500
Total Boxes Produced = 165,000
Fixed overhead absorption rate per box = 115,500/165,000 = $0.7
Variable manufacturing overhead = $2.1 - $0.7 = $1.4
2) Financial advantage (disadvantage) if it buys from outside supplier:-
3) Financial Disadvantage in total (Amount in $)
4) As there is a total disadvantage of $24,750 of buying the tubes from outside supplier, the company should not buy the boxes of tube from outside supplier. Thus Silven industries should make the tubes.
5) The maximum saving in cost per box of tube by buying tubes from outside supplier is $1.85, thus the company will pay upto $1.85 per box of tube only. Thus the maximum price that Silven industries would be willing to pay per box of tube is $1.85.
6) Saving in cost in case the sales volume is 203,000 (Amount in $)
7) As there is a total financial advantage of buying all the tubes from Outside of $39,550 the company should buy all the tubes from outside supplier
Decrease in Direct Material Cost (30% of $4.70) $1.41 Decrease in Direct Labour (10% of $3.00) $0.30 Decrease in Variable manuacturing overhead (10% of $1.4) $0.14 Total Cost avoided by purchasing from outside supplier $1.85