IIM LUCKNOW

SECTION F | GROUP 11

AAKARSH | ABHISHEK | NIVEDHA | MRUNAL | PURBITA

BABA MILK LIMITED

Baba Milk is a household name in the country of Purbita’s Land. It is in the business of packaging and
selling milk and milk products. Mr. Aakarsh, the Co-Founder and CEO wants to introduce a new
product “Milkmania”. It was obvious from market survey and focus discussion groups that there was
a need of new variety of full fat milk. Mr. Aakarsh was very excited about this project as they already
had the technical know-how and distribution channels well established. He could easily make the
market while leading the industry. He called his cost accountant Miss Mrunal to come up with a budget
for the new product. Mr. Aakarsh was a strategic leader and he wanted Miss Mrunal to analyse cost,
processes, and product to make sure he was heading on the right track. One day, the process manager,
Mr Abhi was way too excited as he was about to meet with Mr. Aakarsh. He had devised a new and
more efficient process to produce Milkmania. But to his utter dismay, Mr. Aakarsh asked him to hold
back as the budget for new year was not finalised and said he wanted to make sure to proofread the
figures before taking any final decision whether to go with the new process or not.

Product and Processes

“Milkmania” was made from raw material milk and further processing it to make it rich and full of fat
content. The pasteurisation process used to produce “Milkmania” also resulted in a by-product, whey,
which is full of fibrous matter. “Milkmania” would be marketed at a price of Rs. 50 per mL. Whey
fetched Rs. 0.6 per mL. Additional costs were Rs. 16 per mL for “Milkmania” to package and distribute
and Rs. 0.5 per mL for whey to further process and distribute.

The process manager had developed a process to utilize whey and make whey flavoured milk. A
separate department called Condensation Department was set up to exploit the process developed.
The existing department, in which “Milkmania” was produced, was named as the Pasteurization
Department. The whey flavoured milk needed an additional amount of Rs. 7.5 per mL of the output
for processing and bottling before it could be sold for Rs. 12 per mL under the brand name Wheyed
Milk.

Condensation of whey flavoured milk left hard whey powder. The process manager also discovered
that hard whey powder is not fit for consumption hence it needs to get purified. A type of edible
protein of 1 kg is formed from every 1 kg of hard whey powder in the purification department. This
whey Protein was sold to gyms under the name 'Protein Y', at a price of Rs. 220 per kg. However, the
additional cost for making Protein Y, processed by contract labour, was Rs. 240 per kg of the finished
product. Otherwise, the hard whey powder can be converted into Protein X, which was found to be
of no commercial use and incurred a cost of Rs. 45000.

New Process

In recent months, the process manager had come up with an alternative method of processing whey
in the condensation department, which would improve the quality of wheyed milk so that its selling
price could be increased to Rs. 16 per mL. However, this would mean an increase in processing cost in
condensation department by Rs. 1.5 per mL of Wheyed Milk. Further, the product mix of Wheyed Milk
and hard whey powder would change such that 100,000 mL of milk would produce 18,000 mL of
Wheyed Milk and 600 kg of hard whey powder, instead of 20,000 mL and 500 kg respectively.

Budget for the Year 1997

 IIM LUCKNOW
SECTION F | GROUP 11

AAKARSH | ABHISHEK | NIVEDHA | MRUNAL | PURBITA

Miss Mrunal now had the job to prepare a budget for the product. The availability of raw material,
namely milk was the biggest constraint for the process to fully utilize the capacity. The company could
process up to 15,000 kg of milk per year. The company hoped to procure and process 10,000 kg of
milk for this product. The expected total expenditure was Rs 600,000, out of which Rs 230,000 was
budgeted for the Pasteurization department, Rs 70,000 for the Condensation department, Rs. 40,000
for the purification department, and Rs 260,000 were specific additional costs for the three production
lines. The additional costs were strictly variable in nature, and were mostly spent for bottling, labelling,
packing, etc. 40% of the fixed costs in Pasteurization department, and 30% of the fixed cost in the
Condensation department along with 60% for the purification department were amortizations of
various natures (depreciation, write off preliminary expenses, etc.). At the time of compiling the
budget, the company had not contemplated any change in its processes and products.

Planning for Future

Mr. Aakarsh looked visibly distressed by the situation he was in. He pondered about the changes that
had taken place over the course of launching the new product. Initially he thought there would only
be one product, Milkmania, but now he had many different products, which added to the complexity
of making the right choice and planning for the future. The availability of milk was also uncertain,
which further added to the woes of Mr. Aakarsh. He asked Miss Mrunal to produce the contribution
made by each product, each process, and each department which they were going to operate.
Moreover, he wanted to know what the breakeven points were for operating departments. Miss
Mrunal, being a competent cost accountant, asked Mr. Aakarsh not to worry as she would carry out
all the necessary analyses (following Exhibit 1), which process to adopt, which departments to operate
and some important aspects which slipped off Mr. Aakarsh’s mind.
 IIM LUCKNOW
SECTION F | GROUP 11

AAKARSH | ABHISHEK | NIVEDHA | MRUNAL | PURBITA

Exhibit 1

Particulars Pasteurization Condensation Purification

Direct Material Rs 100,000 * Rs 8,000** Rs 3000***

Direct Labour 50,000 22,000 12000

Fixed Costs 80,000 40,000 25000

Rs 2,30,000 Rs 70,000 Rs 40000

Output

MILKMANIA 10000 ml

Whey 100,000 ml

Wheyed Milk 20,000 ml

Hard Whey Powder (old process) 500 kg

Protein Y (Old process in C. Department) 500 kg

Hard Whey Powder (new process) 600 kg

Protein Y (New process in C. Department) 600 kg

* It includes the row material cost of 10,000 kg milk

**Does not include the cost of 100,000 mL of whey transformed from pasteurization
department
*** Does not include the cost of hard whey powder transformed from the condensation
department

Solution

Options to be evaluated by Miss Mrunal

1. Run only Pasteurization department (*A)

2. Run Condensation department with old process and convert to Protein X (*A+B)

3. Run Condensation department with new process and convert to Protein X (*A+C)

4. Run Condensation and Purification department with old process and convert to Protein Y
(*A+D)

5. Run Condensation and Purification department with new process and convert to Protein
Y (*A+E)
 IIM LUCKNOW
SECTION F | GROUP 11

AAKARSH | ABHISHEK | NIVEDHA | MRUNAL | PURBITA

*reference from the calcutaion

EVALUATION OF THE DECISIONS

When we are running only the Pasteurization department, we will incur the contribution =
10000 * (50 - 16) - 100000 - 50000 + 100000 * (0.6-0.5) = Rs. 20/kg (*A)

Now looking upon the option of using the Condensation department.

If we will run Condensation department only and not the Purification department, we need
to incur a cost of Rs. 45000 to convert the hazardous product Whey Protein into Protein X.

1. Contribution when running Condensation department with old process and

convert the product into Protein X= 20000 * (12 – 7.5) - 8000 - 22000 - 100000
* (0.6 - 0.5) - 45000 = Rs. 0.5/kg (*B)

2. Contribution when running Condensation department with new process and

convert the product into Protein X = 18000 * (16 – 9) - 8000 - 22000 - 100000
* (0.6 - 0.5) - 45000 = Rs. 4.1/kg (*C)

Now looking upon the option of using both Condensation department and Purification
department, where the hazardous product Whey Protein will be converted into Protein Y.

1. Run Condensation department and Purification department with old process

= 20000 * (12 – 7.5) - 8000 - 22000 - 100000 * (0.6 - 0.5) - 3000 - 12000 - 500 *
(240 - 220) = Rs. 2.5/kg (*D)
2. Run Condensation department and Purification department with new process
= 18000 * (16 - 9) - 8000 - 22000 - 100000 * (0.6 - 0.5) - 3000 - 12000 - 600 *
(240 - 220) = Rs. 5.9/kg (*E)

Contribution per unit of raw material (basic input):

OPTION 1: A: Rs 20/kg

OPTION 2: A + B: 20 + 0.5 = Rs. 20.5/kg

OPTION 3: A + C: 20 + 4.1 = Rs. 24.1/kg

OPTION 4: A + D: 20 + 2.5 = Rs. 22.5/kg

OPTION 5: A + E: 20 + 5.9 = Rs. 25.9/kg

Here we will go with option 5 as the contribution of option 5 will be the highest among the
available options.
 IIM LUCKNOW
SECTION F | GROUP 11

AAKARSH | ABHISHEK | NIVEDHA | MRUNAL | PURBITA

Overall break-even point for this firm:

(80000*0.6 + 40000*0.7 + 25000*0.4)/25.9= 3320.46 Kg = 3321 Kg

Departmental break-even points for this firm:

Break Even point for Pasteurization department: (80000 * 0.6) / 20 = 2400

Operate Pasteurization department when milk available more than 2000 kg

Break Even point for Condensation and Purification department: (40000 * 0.7 + 25000 * 0.4) /
5.9 = 6440.67 Kg = 6441 kg

Operate Condensation department and Purification department when milk available are
more than 6441 Kg

Decisions prepared by Miss Mrunal

Raw Material (Kg) Pasteurization department Condensation &

Purification department

< 2400 Don’t Run Don’t Run

2400 - 6441 Run Don’t Run

> 6441 Run Run