Curtis Corporation is beginning to manufacture Mighty Mint, a new mouthwash in a

Question

Curtis Corporation is beginning to manufacture Mighty Mint, a new mouthwash in a small spray container. The product will be sold to wholesalers and large drugstore chains in packages of 30 containers for $18 per package. Management allocates $200,000 of fixed manufacturing overhead costs to Mighty Mint. The manufacturing cost per package of 30 containers for expected production of 100,000 packages is as follows:

Direct material                                    $6.50    

Direct labor                                        $3.50

Overhead (fixed & variable)                 $3.00          

Total                                                  $13.00                 

The company has contacted a number of packaging suppliers to determine whether it is better to buy or manufacture the spray containers. The lowest quote for the container is $1.75 per 30 units. It is estimated that purchasing the containers from a supplier will save 10 percent of direct materials, 20 percent direct labor, and 15 percent of variable overhead. Curtis's manufacturing space is highly constrained. By purchasing the spray containers, the company will not have to lease additional manufacturing space that is estimated to cost $15,000 per year. If the containers are purchased, one supervisory position can be eliminated. Salary plus benefits for this position are $70,000 per year.

Ques: Should Curtis make or buy the containers? What is the incremental cost (benefit) of buying the containers as opposed to making them?                     

Explanation / Answer

Here we need to underatnd the the company is trying to deide between buying empty containers from outside.
Fixed OH per package is = Total Fixed OH/Total packages = $200,000/100,000 = $2 per package
As Total OH is $3 which includes Fixed & Var oh, we know that Var OH = $3-$2=$1per package

Option : Buy 30 Empty container (= 1 pakage) at $1.75 for 30 units.
This will save :-
10% of Dir MaT = 10%*$6.50 = $0.65
20% of Dir Lab = 20%*$3.50 = $0.70
15% of Var OH = 15%*$1.00 = $0.15
-----------------------------------------------
Total saving per package = $1.50
But Buy cost per package is $1.75
SO net expense of Buy decision is $1.50-$1.75 = $0.25 per package
So for 100,000 packages, Addl expense will be $0.25*100,000 = $25,000.........(A)
Saving due to Buy decison is :-
Leasing cost saving $15,000
Supervisor salary $70,000
----------------------------------
Total Saving $85,000.......(B)
So Saving Due to Buy decison = B-A = $85,000-$25,000 = $60,000.......(C)

Now lets look at Revenues :-
1. If we don't buy, COnt pu = Sale price pu - Var cost pu = $18- (6.5+3.5+1.0) = $7pu
So for 100,000 pakges, Total COnt = $7*100,000 = $700,000
Less Fixed OH $200,000 gives Gross Income = $500,000.................(D)

2. If we Buy, Cont PU = $18-[(6.5-0.65)+(3.5-0.70)+(1.0-0.15)]-$1.75 = $6.75pu
So for 100,000 pakges, Total COnt = $6.75*100,000 = $675,000
Less Fixed OH $200,000 gives Gross Income = $475,000
Add : Saving due to Buy decison ( C above) = $60,000
SO Gross Income = $535,000.....................(E)

X. So Curtis should Buy the containers as it is giving an Addl Income (See above D &E) of 535000-500000 = $35,000

Y. Incremental benefit of Buying the container is as per C above $60,000

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