Suppose you have recently been contracted as a financial consultant to a London-
ID: 2774615 • Letter: S
Question
Suppose you have recently been contracted as a financial consultant to a
London-based engineering company, Alpha Products Plc. The company uses
three components as part of their production process, namely, A, B and C.
The budgeted production output for the forthcoming year is to produce
10,000 of each of the three components.
The variable production cost per unit of the final product is as follows:
Only 112,000 hours of machine time will be available during the year, and a
sub-contractor has quoted the following unit prices for supplying the three
components: A £72.50; B £100 and C £88.
(a) Using the above financial data provide calculations which support your
advice to the company on whether it should produce the three components
or outsource them.
(b) Explain the use of the principle of opportunity cost and why costminimisation
and profit maximisation are compatible concepts and include a
table showing the total variable cost of your selected production or purchasing
plan.
Explanation / Answer
By asssuming that the comapny sells the components the oppurutiny cost per machine hour is calculated in the form of contribution per machine hour.
From the above calculations ranking is done from the component where contribution per machine hour is more and then follows a component that has next best contribution and so on.
Therefore ranking of the components is First Component C, then Component B and then Component A has to be produced.
As the limiting factor is 112,000 hours the same should be used for production of component C, and then for producing component B and if any hours available component A should be produced.
Action plan is as follows:
Answer for question no.b:
Oppurtunity cost is the cost which the resource if not put to use one would incur.
Cost minimisation and profit maximization are both compatiable concepts because if one is taken care the other is already achieved. If cost is minimised, it means profit is already maximized.
Total variable cost of production and purchasing plan of selected plan is as follows:
Particulars A B C Price $72.50 $100.00 $88.00 Variable cost $65.00 $90.00 $60.00 Contribution $7.50 $10.00 $28.00 Number of machine hours 6 4 8 Contribution per machine hour $1.25 $2.50 $3.50Related Questions
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