Tamer Mohamed Ali

6-A1 Make or Buy

Vineyard Fruit Company sells premium-quality oranges and other citrus fruits by mail
order. Protecting the fruit during shipping is important so the company has designed and
produces shipping boxes. The annual cost to make 60,000 boxes is as follows:

Therefore, the cost per box averages $2.74.

Suppose Weyerhaeuser submits a bid to supply Vineyard with boxes for $2.24 per box.
Vineyard must give Weyerhaeuser the box design specifications, and the boxes will be
made according to those specs.
1. How much, if any, would Vineyard save by buying the boxes from Weyerhaeuser?
2. What subjective factors should affect Vineyard’s decision about whether to make or
buy the boxes?
3. Suppose all the fixed costs represent depreciation on equipment that was purchased
for $234,000 and is just about at the end of its 5-year life. New replacement equipment
will cost $375,000 and is also expected to last 5 years. In this case, how much, if any,
would Vineyard save by buying the boxes from Weyerhaeuser?

Answer
1- If the company buy boxes from Weyerhaeuser company for 2.24$ per box
Then total cost will be = 2.24 * 60,000= 134,400$
While annual cost for making the same amount of boxes results from Costs saved,
variable costs are ($96,000 + $12,000 + $9,600) = 117,600$
So the company could lose =117,600-134,400= (16,800$) annually if it outsourcing the
boxes from Weyerhaeuser company.

2- Subjective factors that should affect the company decision to make or buy from other
company may be:
- The quality of the boxes.
- The time to deliver the boxes.
- The storage for the boxes.

3- If the company was planning to buy new machines for making boxes with cost of
375,000$ and depreciation rate of 5 years.
So annually fixed indirect manufacturing cost will be = 375,000 / 5 = 75,000$ per year
Annually total cost will be = 96,000+12,000+9,600+75,000= 192,600$
In this case the company will save 192,000 – 134,400 = 58,200 $ per year if they will
outsourcing the boxes from another company.

6-A3 Joint Products: Sell or Process Further

The Mussina Chemical Company produced three joint products at a joint cost of
$117,000. These products were processed further and sold as follows :
The company has had an opportunity to sell at split-off directly to other processors. If
that alternative had been selected, sales would have been A, $54,000; B, $32,000; and
C, $54,000. The company expects to operate at the same level of production and sales
in the forthcoming year.
1. Could the company increase operating income by altering its processing decisions? If
so, what would be the expected overall operating income?
2. Which products should be processed further and which should be sold at split-off?

Answer
1- for product A

Sales at split off Processing Difference

Sales 54,000 230,000 176,000
Costs after split off 0 (190,000) (190,000)
Net income 54,000 40,000 (14,000)

For product B

Sales at split off Processing Difference

Sales 32,000 330,000 298,000
Costs after split off 0 (300,000) (300,000)
Net income 32,000 30,000 (2,000)

For product C

Sales at split off Processing Difference

Sales 54,000 175,000 121,000
Costs after split off 0 (100,000) (100,000)
Net income 54,000 75,000 21,000

So if the company take decision for further processing the total income will be =
40,000+30,000+75,000 = 145,000 $

While if it sells at split point without processing it will be =

54,000+32,000+54,000 = 140,000 $

So total income will increase by 5,000 $

2- It is clear that both products A, B will be more profitable if they were sold at split off point not
after processing, while product C will be more profitable to be further processing.

This will results in best increasing in net income as= 54,000+32,000+75,000=161,000 $

6-B1 Make or Buy

Suppose a BMW executive in Germany is trying to decide whether the company should
continue to manufacture an engine component or purchase it from Frankfurt
Corporation for €50 each. Demand for the coming year is expected to be the same as
for the current year, 200,000 units. Data for the current year follow:

If BMW makes the components, the unit costs of direct material will increase by 10%.
If BMW buys the components, 30% of the fixed costs will be avoided. The other 70%
will continue regardless of whether the components are manufactured or purchased.
Assume that variable overhead varies with output volume.
1. Prepare a schedule that compares the make-or-buy alternatives. Show totals and
amounts per unit. Compute the numerical difference between making and buying.
Assume that the capacity now used to make the components will become idle if the
components are purchased.
2. Assume also that the BMW capacity in question can be rented to a local electronics
firm for €1,150,000 for the coming year. Prepare a schedule that compares the net
relevant costs of the three alternatives: make, buy and leave capacity idle, buy and rent.
Which is the most favorable alternative? By how much in total?

Answer
1- If BMW decided to buy that component from another company then the total cost for
this purses will be = 50 € * 200,000 = 10,000,000 €
But if BMW decided to make it then:
Direct material will be = 5,000,000+ (10% * 5,000,000) = 5,500,000 €
Factory overhead fixed cost will be decreased by 30% (avoidable cost)
So the 70% will not change (unavoidable cost)
Unavoidable cost = 70% * 3,000,000=2,100,000 €
And voidable cost = 30% * 3,000,000 = 900,000 €
So total cost for making the component will be
 = direct material + direct labor + factory OH variable + factory OH fixed =
5,500,000+1,900,000+1,100,000+900,000 = 9,400,000 €
Cost per unit = 9,400,000 / 200,000 = 47 €
So BMW could reduce its cost by making this component not buying it by 3 € for each
unit or 600,000 € per year.

2- If BMW buy the component and rent the factory for another company to gain rent
revenue 1,150,000 € per year then we can summarize this in a table as:
Make Buy and leave capacity Buy and rent
idle
(9,400,000) (10,000,000) 1,150,000
(10,000,000)
-----------------
(8,850,000)
47 € / unit 50 € / unit 44.25 € / unit

6-B3 Dropping a Product Line

Hamleys Toy Store is on Regent Street in London. It has a magic department near the
main door. Suppose that management is considering dropping the magic department,
which has consistently shown an operating loss. The predicted income statements, in
thousands of pounds (£), are (for ease of analysis, only three product lines are shown):

The £300,000 of magic department fixed expenses include the compensation of

employees of £120,000. These employees will be released if the magic department is
abandoned. All of the magic department’s equipment is fully depreciated, so none of the
£300,000 pertains to such items. Furthermore, disposal values of equipment will be
exactly offset by the costs of removal and remodeling.
If the magic department is dropped, the manager will use the vacated space for either
more general merchandise or more electronic products. The expansion of general
merchandise would not entail hiring any additional salaried help, but more electronic
products would require an additional person at an annual cost of £30,000. The manager
thinks that sales of general merchandise would increase by £250,000, and electronic
products by £200,000. The manager’s modest predictions are partially based on the fact
that she thinks the magic department has helped lure customers to the store and, thus,
improved overall sales. If the magic department is closed, that lure would be gone.
Should the magic department be closed? Explain, showing computations.

Answer

If the management decided to drop the magic department so Current situation is:
 Total General March. Elec. Prodt. Magic Department.
Sales £6,000 £ 5,000 £400 £600
Variable expenses 4,090 3,500 200 390
Contribution margin 1,910(32%) 1,500(30%) 200(50%) 210(35%)
Fixed expenses 1,100 750 50 300
Operating income (loss) £ 810 £ 750 £150 £ (90)
But if they dropped the Magic department the new computation will be
The Fixed expenses include the compensation of employees of £120,000 this amount will be
eliminated if they close the department so will be calculated as avoidable cost.
Total with Magic Magic without Magic
Sales £6,000 £600 5,400
Variable expenses (4,090) (390) (3,700)
Contribution margin £ 1,910 £ 210 £ 1,700
Fixed expenses (1,100) (120) (980)
Operating income (loss) £ 810 £ (90) £ 720
So the total operating income will dropped about 11.11% if they closed the magic department

Then if they decided to increase the capacity of one of two department so

1- Expansion of general merchandise department after drop Magic department will results in
Sales of general merchandise would increase by £ 250,000
And Contribution margin will be 30% of incremental revenues is £ 75,000
So Variable Expense will be 250,000-75,000=175,000 £

Total without Magic increased Capacity for GM Total

Sales 5,400 250 5,650
Variable expenses (3,700) (175) (3,875)
Contribution margin £ 1,700 £ 75 (30%) 1.775
Fixed expenses (980) --- (980)
Operating income (loss) £ 720 £ 75 £ 795
2- Expansion of Electronic products department after drop Magic department will results in
Sales of Electronic products would increase by £200,000
And Contribution margin will be 50% of incremental revenues is 100,000 £
And fixed expense for an additional person working with annual cost of £30,000

Total without Magic increased Capacity for EP Total

Sales 5,400 200 5,650
Variable expenses (3,700) (100) (3,875)
Contribution margin £ 1,700 £ 100(50%) 1.800
Fixed expenses (980) (30) (1010)
Operating income (loss) £ 720 £ 70 £ 790

In both cases the total net operating income will be lower than previous one when the magic
department is opening, so the store should not close the magic department or the operating
income will decreased by 11.11% if they close it, 1.85% if they close it and expand in GM and
2.47% if they closed it and expand in EP.

6-B4 Sell or Process Further

ConAgra produces meat products with brand names such as Healthy Choice, Armour,
and Butterball. Suppose one of the company’s plants processes beef cattle into various
products. For simplicity, assume that there are only three products: steak, hamburger,
and hides, and that the average steer costs $700. The three products emerge from a
process that costs $100 per steer to run, and output from one steer can be sold for the
following net amounts:

Assume that each of these three products can be sold immediately or processed further
in another ConAgra plant. The steak can be the main course in frozen dinners sold
under the Healthy Choice label. The vegetables and desserts in the 400 dinners
produced from the 100 pounds of steak would cost $110, and production, sales, and
other costs for the 400 meals would total $330. Each meal would be sold wholesale for
$2.10.
The hamburger could be made into frozen Salisbury steak patties sold under the
Armour label. The only additional cost would be a $200 processing cost for the 500
pounds of hamburger. Frozen Salisbury steaks sell wholesale for $1.70 per pound.
The hide can be sold before or after tanning. The cost of tanning one hide is $80, and a
tanned hide can be sold for $170.
1. Compute the total profit if all three products are sold at the split-off point.
2. Compute the total profit if all three products are processed further before being sold.
3. Which products should be sold at the split-off point? Which should be processed
further?
4. Compute the total profit if your plan in number 3 is followed.

Answer
1- If the three products are sold at split off
So the three products emerge from a process that costs $100 per steer and output from
one steer can be as:
Steak (100 pound) + Hamburger (500 pound) + Hide (120 pound) =
400+600+100=1,100 $
But there is a joint cost =100+700 = 800$ per steer
So total profit for selling 3 products from 1 steer = 1,100-800= 300$
2- Total profit for 3 products if they were processed further will be as
Total meals came from 100 pound of Steak = 400
Total sales for 400 meals = 2.1 * 400 =840$
Total cost processing for 400 meals = 330+110= 440$
Frozen Salisbury steaks from 1 pound Hamburger = 1.70$
Total sales from 500 pound of Hamburger = 1.7 * 500= 850$
Total cost to process 500pound of Hamburger = 200$
The cost of tanning 1 hide = 80 $
Total sales for 1 tanned hide = 170 $

Product Steak Hamburgers Hide Total

Sales 840 850 170 1,860
Separable costs 440 200 80 720
Joint Costs 800
Total profit 400 650 90 340
So total profit for 3 products if we take into consideration the joint cost will be 340 $

3- for Steak
Sales at split off Processing Difference
Sales 400 840 440
Costs after split off 0 (440) (440)
Net income 400 400 0
So processing further for Steak will not affect the net income, but other qualitative
factors may be taken into consideration here.

For Hamburger
Sales at split off Processing Difference
Sales 600 850 250
Costs after split off 0 (200) (200)
Net income 600 650 50
So processing further for Hamburger will increase the total net income by 50 $, this
means that company should process further.

For Hide
Sales at split off Processing Difference
Sales 100 170 70
Costs after split off 0 (80) (80)
Net income 100 90 (10)
So processing further for Hide will decreases the total net income by 10 $, this means
that company should sell at split off.
4- Total profit if steak and hamburger process further and hid sell at split off point will be
= 400+650+100 – 800 = 350$
So total profit for 3 products according to this plan if we take into consideration the joint
cost will be 350 $.

6-32 Make or Buy

Assume that a division of Bose makes an electronic component for its speakers. Its
manufacturing process for the component is a highly automated part of a just-in-time
production system. All labor is considered to be an overhead cost, and all overhead is
regarded as fixed with respect to output volume. Production costs for 100,000 units of
the component are as follows:

A small, local company has offered to supply the components at a price of $4.20 each. If
the division discontinued its production of the component, it would save two-thirds of the
supplies cost and $30,000 of indirect-labor cost. All other overhead costs would
continue.
The division manager recently attended a seminar on cost behavior and learned about
fixed and variable costs. He wants to continue to make the component because the
variable cost of $4.00 is below the $4.20 bid.
1. Compute the relevant cost of (a) making and (b) purchasing the component. Which
alternative is less costly and by how much?
2. What qualitative factors might influence the decision about whether to make or to buy
the component?

Answer
1- If Bose company will buy this component by 4.20$ / unit
Total cost will be 4.20 * 100,000 = 420,000 $
But if the company decided to make it
The supplies cost will be 20,000 $ (two-thirds of current cost)
Indirect-labor cost will be 30,000 $
But allocated occupancy cost will remain unchanged so it considered as irrelevant
cost to the component production.
So total cost will be = DM +In DL + Supplies =
= 400,000+30,000+20,000 = 450,000 $
This is 4.5 $ per unit
This means that the company will save 0.3$ per unit if it buy the component from
another company and will save 30,000 $ for 100,000 unit production.
2- The qualitative factors that could influence the decision to make or buy in this
case is:
The quality of the product
The long term relation with the supplies and customers
The storage and transportation for this component

6-36 Deletion of Product Line

St. Gallen American School is an international private elementary school. In addition to
regular classes, after-school care is provided between 3:00 PM and 6:00 PM at CHF 10
per child per hour. Financial results for the after-school care for a representative month
are as follows:

The director of St. Gallen American School is considering discontinuing the after-school
care services because it is not fair to the other students to subsidize the after-school
care program. He thinks that eliminating the program will free up CHF 1,300 a month to
support regular classes.
1. Compute the financial impact on St. Gallen American School from discontinuing the
after-school care program.
2. List three qualitative factors that would influence your decision.

Answer
I- In this case the avoidable cost will contain teacher’s salaries +supplies only
{Other fixed costs, depreciation and sanitary engineering are not avoidable}
So avoidable cost =5,300+1,200 =6,500 CHF
The decrease in operating income resulting from after- school care program is
=7,500-6,500= 1000 CHF
So if they decided to discontinuing the after school program they will lose 1000 CHF
2- Factors that could affect the management decision are: the students could affected
by the closing of it (educational effect), the teachers could lose some of the monthly
income they gain and some supplies revenues will decrease from closing it.
6-37 Sell or Process Further
An Exxon petrochemical factory produces two products, L and M, as a result of a
particular joint process. Both products are sold to manufacturers as ingredients for
assorted chemical products.
Product L sells at split-off for $.25 per gallon; M sells for $.30 per gallon. Data for April
follow:

Suppose that in April the 2,500,000 gallons of M could have been processed further into
Super M at an additional cost of $165,000. The Super M output would be sold for $.36
per gallon. Product L would be sold at split-off in any event.
Should M have been processed further in April and sold as Super M? Show your
computations.

Answer
Total sales for M at split off point = 0.3 * 2,500,000 = 750,000 $
Total sales for Super M = 0.36 * 2,500,000 = 900,000 $
For product M
Sales at split off Process to Super M Difference
Sales 750,000 900,000 150,000
Costs after split off 0 (165,000) (165,000)
Net income 750,000 735,000 (15,000)
So if EXXON did process M to Super M during April this could results in reducing sales
for the company by almost 2% {15,000 $ }

6-47 Make or Buy

Dana Corporation, based in Toledo, Ohio, is a global manufacturer of highly
engineered products that serve industrial, vehicle, construction, commercial, aerospace,
and semiconductor markets. It frequently subcontracts work to other manufacturers,
depending on whether Dana’s facilities are fully occupied. Suppose Dana is about to
make some final decisions regarding the use of its manufacturing facilities for the
coming year.
The following are the costs of making part EC113, a key component of an emissions
control system:

Another manufacturer has offered to sell the same part to Dana for $28 each. The fixed
overhead consists of depreciation, property taxes, insurance, and supervisory salaries.
All the fixed overhead would continue if Dana bought the component except that the
cost of $130,000 pertaining to some supervisory and custodial personnel could be
avoided.
1. Assume that the capacity now used to make parts will become idle if the parts are
purchased. Should Dana buy or make the parts? Show computations.
2. Assume that the capacity now used to make parts will either (a) be rented to a nearby
manufacturer for $25,000 for the year or (b) be used to make oil filters that will yield a
profit contribution of $15,000. Should Dana buy or make part EC113? Show your
computations.

Answer
1- If Dana Corporation want to buy from another company it will cost it
= 28 * 65,000 = 1,820,000 $
But if this corporation want to make this:
Fixed factory overhead will be 130,000 $ only because only avoidable cost will be
calculated
So total manufacturing cost will be = DM+DL+V F OH+FF OH=
= 585,000+715,000+650,000+130,000=2,080,000 $
This indicates that in case of buy from outsourcing the company will save
=2,080,000-1,820,000=260,000 $
So it is better to the company to buy this part not to make it.
2- a) if the company rent the factory to another with rate of 25,000$
Then the total cost will be = 1,820,000-25,000= 1,795,000$
b) If the company produce another type of products with profit 15,000$
Then total cost will be = 1,820,000-15,000=1,805,000$
So the company should buy and rent the factory for 25,000$ this could be lower cost.