You are required to prove how knowledge of marginal costing can help management in changing the sales mix in order to increase profits of the company.

The company is t replace a number of its machines and the production manager are torn between the EXE machine, a more expensive machine with the life of 12 years and Wye machine with a life of 6 years.  If the Wye machine chosen it is likely that it would be replaced at the end of 6 years by another Wye machine.  The pattern of maintenance and running costs differs between the two types of machine and relevant data are shown below

You are required to

• Recommend with supporting figures which machine to purchase

Material (3 kgs @ Rs2 per kg) – Rs. 6

Labour Rs. 5

Variable overhead Rs. 4

Allocated Fixed overhead Rs. 2

Material is currently used to make chairs which provide contribution of Rs. 5 per unit.  2 kgs of material is required for each chair.  What is the minimum price per desk if material is plentiful and material is scarce?

The group’s cost of capital is 13%.  Should the project be accepted or rejected?

The direct labour wage rate is Rs. 4 per hour.  Fixed overhead have been allocated on the basis of direct labour hours.  The company has commitments to produce a minimum of 400 units of each product per month.  Direct labour hours cannot exceed 13000 per month due to restriction of space.  The board is now considering an offer of a new three year contract to produce an additional 400 units of product B per month at a selling price of Rs. 58 per unit.  The contract would involve an outlay of Rs. 100000 on the lease of additional factory premises and purchase of new plant and equipment.  There would be no residual value at the end of the contract.  Variable production costs would be in accordance with existing standards, variable selling and distribution costs would be one half of the existing rate and cash outflows on fixed costs would be Rs. 20000 per annum.  An outside supplier has offered to supply 400 units of product B per month at a price of Rs. 48 per unit.  If purchased externally cash flows on additional fixed costs will be Rs. 25000 per annum

Required

• Give recommendations supported by calculations to show how direct labour hours in the existing factory should be utilized in order to maximize profits
• Show the budgeted trading results on the basis of your recommendation
• Give calculations to show whether or not the proposed contract for product B should be accepted and if so, whether it should be purchased externally or manufactured in the new premises.

Details of the three products for the typical period are

Direct labour costs Rs. 6 per hour and production overhead are absorbed on a machine hour basis.  The rate for the period is Rs. 28 per machine hour.

Further analysis shows that the total of production overheads can be divided as follows

The following activity volumes are associated with the product line for the period as a whole.  Total activities for the period

You are required

• To calculate the cost per unit for each product using conventional method
• To calculate the cost per unit for each product using Activity Based Costing
• Comment on the differences

Another manufacturer has offered to sell the same part to XYZ ltd at Rs. 22 each.

The fixed overhead would continue to be incurred even when the component is bought out although there would be a reduction to the extent of Rs. 150000 following the savings in salaries of supervisor personnel that could be avoided if the company opts to buy rather than to make.

• Should the part be made or bought, considering that the present facility when released following the buying decision would remain idle?
• In case the released capacity can be rented to another manufacturer for Rs. 50000 what will be the position?

(‘000)

Figures in brackets represent cash outflows

All projects are divisible.  None of the projects can be delayed or undertaken more than once.  Calculate which project the company should undertake if the capital available for investment is limited to Rs. 1, 10,000 in year 1 and with no limitation in subsequent years.

Raw materials per unit Rs. 0.45

Direct wages per unit 0.18

Mfg overheads (fixed )200% of direct wages

Selling and admin overhead 100% of direct wages

Packing per unit Rs. 0.15

Profit margin on total costs

15% for 75000 units

12.5% for 90000 units

10% for 105000 units

The administration overheads are forecast at Rs. 18750 per month.  If the output drops to 75000 units and below, a saving in administration cost of Rs. 1500 per month will be made.  If the contract from SMA does not materialize an administration overheads of Rs. 900 per month will be incurred.

Another customer SMB has also approached the company for a quotation for a different version of the product.  The quantity required of this product is 90000 units per month.  The data relating to this contract are as under:

Selling price per unit Rs. 1.80

Raw materials per unit Rs. 0.80

Direct wages per unit 0.22

Packing per unit Rs. 0.18

Required:

• Calculate the unit selling prices for the three levels of output of the contract relating to SMA
• Prepare a comparative statement of profitability at different levels of output as envisaged in the two contracts of SMA and SMB
• Advice which contract should be acceptable to the company.