CHAPTER XVII

DECISIONS INVOLVING ALTERNATIVE CHOICES

SOLUTION TO SELF EVALUATION PROBLEMS

SOLUTION 1

Marginal Cost For The Current Year

Direct material 4.20

Direct wages 1.20

Variable overheads:

Works overhead 3.00

Sales overhead 0.25

Total marginal cost 8.65

Contribution per unit 6.35

Selling price 15.00

Statement of Profit on Sales of 60,000 Units

Rs.

Sales

9,00,000

Less: Variable cost (60,000 x 8.65)

5,19,000

Contribution

3,81,000

Less: Fixed costs:

Works overheads (1,80, 000 + 18,000) 1,98,000

Sales overheads (45,000 + 4,500) 49,500

2,47,500

Profit

1,33,500

Profit required 1,80,500

Profit on 60,000 units 1,33,500

Profit to be earned on 20,000 units Rs. 47,000

Statement of Minimum Selling Price Per Unit – For an Order of 20,000

Rs.

costs 20,000 x 8.65 1,73,000

Desired profit 47,000

Total sales 2,20,000

Selling price per unit = 2,20,000 =

20,000

Rs.11

The above can be verified as under:

Sales 60,000 units x 15 = 9,00,000

20,000 units x 11 = 2,20,000

Less: 11,20,000

Variable costs: 80000 x 8.65 = 6,92,000

Fixed costs = 2,47,500 9,39,500

Profit 1,80,500

SOLUTION 2

(a)

Statement Showing the Variable Cost and Purchase Cost of Component...

Used by Auto Link Ltd.

Variable Cost Per Unit for

90,000 units Rs.

Total

Rs.

Materials 270 24300000

Labour 135 12150000

Expenses 90 81 00 000

Total variable cost (when component is

produced)

495 44550000

Cost of purchase (when component is

purchased)

540 4 86 00 000

Difference, excess of purchase price over

variable cost

45 4050000

Fixed expenses not being affected, it is evident from the above statement that if

the component is purchased from the outside supplier, the company will have to spend

Rs. 45 per unit more and on 90,000 units, the company will have to spend Rs. 40,50,000

more. Therefore, the company should not stop the production of the component.

(b) The following statement shows the cost implications of the proposal to divert the

available facilities for a new product.

Statement showing the contribution per unit if the existing resources are

used for the production of another new product:

(Rs.)

(Rs.)

Selling price of the new product per unit

485

Less: Materials cost 200

Labour (variable) 135

Expenses (variable) 90

425

Contribution per unit

60

Loss per unit if the present component is purchased:

Purchase price of the existing product

540

Less: Total variable cost of producing the existing component

495

Excess cost 45

Thus, if the company diverts its resources for the production of another new

product, it will benefit by Rs. 15, i.e. Rs. 60 - 45 per unit. On 90,000 units, the company

will save Rs. 13,50,000. Therefore, it is advisable to divert the resources to manufacture the

new product and the component presently being produced should be purchased from the

market. This is also brought out by the following figures:

Rs.

Total cost producing the component 90,000 x 675 A 6,07,50,000

Cost of purchasing the component 90,000 x 540 4,86,00,000

Fixed expenses, not having been saved 90,000 x 180, i.e.675-495 1,62,00,000

6,48,00,000

Less: Contribution from the new product 90,000 x 60 54,00,000

Total cost if component is purchased and new product is

purchased and new prduct is made B 5,94,00,000

Savings A – B 1350000

SOLUTION 3

i Economies of two export proposals:

Order from Canada

for Product A

Order from Middle

East for Product B

Marginal cost per unit:

Materials 2.00 4.00

Labour 4.00 4.00

Variable factory overheads 3.00 1.20

Variable selling and administration

Overheads

3.20 3.00

Special packing charges 0.50 0.50

Total variable cost 12.70 12.70

Export price per unit 17.50 15.50

Contribution per unit 4.80 2.80

Since machine hour is the limiting (key) factor, the contribution should be linked

with the machine hours. This has been worked out as follows:

Machine hour per unit 2.5 hours 1.5 hours

Contribution per machine hour Rs. 1.92 Rs. 2.13

Product B yields a better contribution per machine hour.

The order from the Middle East should therefore be accepted as compared to the

Canadian offer.

Working Notes:

A B Total

Factory overheads per unit Rs. 5 Rs.3

Machine hour rate per hour Rs.2 Rs.2

Units Produced 600 400

Machine hours utilized 1500 600 2100

Level of activity 75%

Machine hours at 100 % activity : 2,100 x 100 = 2,800 hr.

75

Capacity hours available for export 2,800 – 2,100 = 700 hr.

(ii) Statement of Overall Profitability

Units Product A

600 Rs.

Product B

867 Rs.

Total

Rs.

Materials 1200 3468 4668

Labour Based on capacity 2400 1600 4000

Factory overhead:

Variable 1800 1561 3361

Fixed 1200 480 1680

Selling & Admn. Overheads:

Variable 1920 1734 3654

Fixed 2880 1200 4080

Special packing – 234 234

Total costs 11400 10277 21677

Sales 13800 14839 28639

Profit 2400 4562 6962

Working notes

1. Number of units of B:

Sales in the home market 400

Export market 700 hr/1.5 467

Total 867

2. Sales values of B:

400 units in the home market @ Rs. 19 Rs. 7600

467 units for export @ Rs. 15.50 Rs.7839

Total: Rs. 14,839

SOLUTION 4

Decision analysis (continue or shut down the factory):

Amount in Lakh

Particulars Operate the

factory

Shut-down the

factory

Differential

revenue and

costs

Sales revenue 18.51 – 18.51

Cost:

Direct material 6.40 – 6.40

Direct labour 4.80 – 4.80

Factory expenses (variable) 0.96 – 0.96

Administrative expenses

(variable)

0.32 6.00 0.12

Administrative expenses (fixed) 3.24 – 3.24

Selling' and distribution expenses

(variable)

0.48 – 0.48

Selling and distribution expenses

(fixed)

3.36 – 3.36

Closing down costs:

Redundancy payments – 2.00 2.00

Maintenance of plant – 0.50 0.50

Overhauling costs – 0.80 0.80

Total Cost 19.56 9.30 10.26

Differential revenue favouring the decision to operate the plant