Fact Pattern: Rosecrans Manufacturing produces kerosene lanterns. The company can sell all of its output. Each unit sells for $120, and direct materials costing $48 per unit are added at the start of the first operation. Other variable costs are immaterial. Production data for one of its products is presented below:
|
|
Operation 1
|
Operation 2
|
Operation 3
|
|
|
|
|
|
|
Total capacity per year
|
200,000 units
|
150,000 units
|
180,000 units
|
|
Total output per year
|
150,000 units
|
150,000 units
|
150,000 units
|
|
Fixed cost of operations
|
$1,200,000
|
$1,800,000
|
$2,250,000
|
|
| |
|
| Question4) |
Tullahoma Company has offered to perform the Operation 2 function on 1,000 units at a unit price of $40, excluding direct materials cost. Chattanooga Company has offered to perform the Operation 1 function on 1,000 units at a price of $7, excluding direct materials cost. Chickamauga Company has made an offer to perform the Operation 1 function on 5,000 units at a unit cost of $5 (excluding direct materials cost). Which of these mutually exclusive offers is acceptable to Rosecrans? |
|
|
|
|
|
|
|
|
Answer (C) is correct.
Tullahoma's offer should be accepted because its cost is $40,000 (1,000 units × $40), and the increase in throughput contribution is $72,000 [1,000 units × ($120 unit price – $48 DM per unit)]. Hence, the relevant cost of Tullahoma's offer is less than the incremental throughput contributed. Tullahoma's offer effectively increases the capacity of the bottleneck operation. Chattanooga's and Chickamauga's offers should both be rejected because, even though their $7 and $5 unit costs are less than the $8 unit operating cost (excluding direct materials) for Operation 1 ($1,200,000 fixed costs ÷ 150,000 units), they will result in the incurrence of additional costs with no increase in throughput contribution, given that Operation 2 is already producing at its 150,000-unit capacity.
|
|
------------------------------
Tayba Al-Mehdar
Controller
Khobar
Saudi Arabia
------------------------------