IMBA CASE 3

Presented below are four independent situations which you as a Manager Trainee employed with Your
Company have been asked to evaluate. Evaluate each situation based on what each requires. To receive a
promotion depends upon how your respond.

Situation One

Your Company makes 42,000 units per year of a part it uses in the products it manufactures. The unit product
cost of this part is computed as follows:

Direct material 15.00  630,000 Buy 42,000 x 51.80 = 2,175,600

Direct labor 18.00 756,000 Difference: 621,600
Variable manufacturing overhead 4.00 168,000
Fixed manufacturing overhead 25.00 Irrelevant
Unit product cost $62.00 1,554,000 total

An outside supplier has offered to sell the company all of these parts it needs for $51.80 a unit. If the company
accepts this offer, the facilities now being used to make the part could be used to make more units of a product
that is in high demand. The additional contribution margin on this other product would be $268,000 per year.
If the part were purchased from the outside supplier, all of the direct labor cost of the part would be avoided.
However, $17.00 of the fixed manufacturing overhead cost being applied to the part would continue even if the
part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the
company's remaining products.
Required:

a. How much of the unit product cost of $62.00 is relevant in the decision of whether to make or buy the part?
$37.00

b. What is the net total dollar advantage (disadvantage) of purchasing the part rather than making it?
Manufacturing Cost: 42,000 X 37 = 1,554,000
Contribution Margin 268,000
Cost of purchasing part 2,175,600

Net advantage of making the product: 2,175,600 – 1,554,000 = 621,600

 
 
c. What is the maximum amount the company should be willing to pay an outside supplier per unit for the part
if the supplier commits to supplying all 42,000 units required each year?

Manufacturing Cost 1,554,000

Contribution Margin 268,000

Total Benefit 1,822,000

Units 42,000

Maximum amount that the company should pay : 1,822,000 / 42,000 = $43.48

Situation Two

Your Company produces a single product. The cost of producing and selling a single unit of this product at the
company's normal activity level of 40,000 units per month is as follows:

Direct material $54.00 160,000

Direct labor 5.00 15,000
Variable manufacturing overhead 2.00 6,000
Fixed manufacturing overhead 13.00
Variable selling and administrative expense 2.00 3,000
Fixed selling and administrative expense  8.00

The normal selling price of the product is $92.00 per unit.

An order has been received from an overseas customer for 3,000 units to be delivered this month at a special
discounted price. This order would have no effect on the company's normal sales and would not change the total
amount of the company's fixed costs. The variable selling and administrative expense would be $1.00 less per
unit on this order than on normal sales.
Direct labor is a variable cost in this company.
Required: $10.10 difference in unit price

a. Suppose there is ample idle capacity to produce the units required by the overseas customer and the special
discounted price on the special order is $81.90 per unit. By how much would this special order increase
(decrease) the company's net operating income for the month? 245,700.00

Normal Sales: Variable Cost Special order: Selling Price

Direct Materials $54.00
Direct Labor 5.00
Variable Manufacturing Overhead 2.00
Variable Selling and Admin 2.00
Variable cost per unit 54+5+2+2 = 63.00
Normal Variable cost 63.00
Reduction of Variable selling admin - (1.00)
Variable cost per unit Special order 62.00

Selling Price Special Order $ 81.90

Variable cost per unit special order 62.00
Contribution Margin per unit Special order 81-62= 19.00
Units in Special order 3,000 units
Increase in net operating Income 30,000 x 19= 57,000

b. Suppose the company is already operating at capacity when the special order is received from the overseas
customer. What would be the opportunity cost of each unit delivered to the overseas customer?

Normal Selling price $92.00

Variable cost per unit normal sales 63.00
Contribution margin per unit normal sales 92-63 = $29.00

c. Suppose there is not enough idle capacity to produce all of the units for the overseas customer and accepting
the special order would require cutting back on production of 2,100 units for regular customers. What would be
the minimum acceptable price per unit for the special order? 

Contribution Margin per unit 29.00

Lost Contribution margin 2,100 x 29.00 = 60,900
 Total Variable Cost Special order 3,000 x 62.00 = 186,000
Incremental cost Special order 186,000 + 60,900 = 246,900
Specail order units 3,000
Minimum Acceptable price for Special order 246,9000 / 3000 = 82.30
 

 
 

Situation Three

Your Company makes three products in a single facility. These products have the following unit product costs:

Product A Product B Product C

Direct material $25.00 $25.00 $26.00

Direct labor 14.00 16.00 15.00
Variable manufacturing overhead 2.00 3.00 4.00
Fixed manufacturing overhead 20.00 27.00 21.00

Unit cost $61.00 $71.00 $66.00

Additional data concerning these products are listed below:

Product A Product B Product C
Mixing minutes per unit 2.50 1.50 1.80
Selling price per unit $71.00 $88.00 $82.00
Variable selling cost per unit $2.50 $2.00 $3.50
 Monthly demand in units 1,000 2,500 3,500

The mixing machines are potentially the constraint in the production facility. A total of 10,800 minutes are
available per month on these machines.
Direct labor is a variable cost in this company.
Required:

a. How many minutes of mixing machine time would be required to satisfy demand for all four products?
Mixing minutes per unit:

A. B C
2.50 1.50 1.80
1,000 2,500 3,500
2,500 3,750 6,300

12,550

b. How much of each product should be produced to maximize net operating income? (Round off to the nearest
whole unit.)

Selling Price Per

$61.00 $71.00 $66.00
Unit
Direct Materials $25.00 $25.00 $26.40
Direct Labor 14.00 16.00 15.00
Variable MOH 2.00 3.00 4.00
Variable Selling Cost
2.50 2.00 3,50
Per Unit
Total Variable Cost
$43.50 $46.00 $48.90
Per Unit
Contribution Margin
$17.50 $25.00 $17.10
Per Unit
Mixing Minutes per
2,50 2.00 3.50
Unit
Contribution Margin
$15.00 $23.00 $13.60
Per Minute
Rank in Terms of
2 1 3
Profitability
Optimal Production ? 2,500 3,500

c. Up to how much should the company be willing to pay for one additional hour of mixing machine time if the
company has made the best use of the existing mixing machine capacity? (Round off to the nearest whole cent.)
13.60
 

 
 

Situation Four

The most recent monthly income statement for Your Company is given below:
Store A Store B Total
Sales $500,000 $700,000 $1,200,000
Variable expenses 200,000 490,000 690,000
Contribution margin 300,000 210,000 510,000
Traceable fixed expenses 125,000 300,000 425,000
Store segment margin 175,000 (90,000) 85,000
Common fixed expenses 25,000 35,000 60,000
Net operating income $150,000 $ (125,000) $ 25,000

Due to its poor showing, consideration is being given to closing Store B. Studies show that if Store B is closed,
one-fourth of its traceable fixed expenses will continue unchanged. The studies also show that closing Store B
would result in a 15 percent decrease in sales in Store A. The company allocates common fixed expenses to the
stores on the basis of sales dollars.
Required:
Compute the overall increase or decrease in the company's operating income if Store B is closed.