Busines Management

7/28/2019 Busines Management

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Decision Making 1

Learning objective

In this chapter we will check different types decision making problems as faced by topmanagement on day-to-day operation basis. Management has to consider the best alternative

situations so that the profit of the organisation will increase. Some of these are as follows1. product sales pricing & mix2. limiting factors3. multiple scare resource problem ( Ref chapter 10a)4. make or buy5. selection of products, etc etc

Introduction:

Decision making are of 2 types.

(1) Long term decision making :For this purpose we generally apply capital budgeting technique.

(2) Short term decision making ( i.e. generally in one financial year)(a) Pricing decision for the particulars period for which we apply different pricing

techniques.(b) Other than pricing decision such as-

(i) Except or reject an offer(ii) Make or buy the product or slab component(iii) Sale or process(iv) Exploring new foreign market.

(v) Discontinue of a product(vi) Shut down of a factory etc.

In this way there may be different type of heading.However, the solution technique are limited to four only :

(1) Problem of limiting factor or limiting factor approach ( for common process applicable for morethan 1 product).

(1) Differential cost & incremental Revenue analysis where the production & sales will continue tillMarginal Revenue > Marginal costs.

(3) Indifference cost approach

(4) Relevant cost approach i.e. considered only those cost & revenues which are related to thepurpose or decision. Generally we considered the following 3 items for this purpose.

(a) Variable cost of the proposal(b) Discretionary Fixed cost(c) Opportunity cost

If the price offered by the customer is more than the total relevant cost, then the offer isaccepted.

In case of problem where minimum sale price is to be quoted then total relevant cost = Totalminimum sales price.


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Decision Making 2

Limiting Factor Problems

When many products are produced from a single resource & total resources requirementof the product is greater then resource available, then it known as limiting factor ofproduction.

Objective of the management maximization of contribution or contribution-DiscretionaryFixed cost.

Step-1:Compute contribution p.u. & identify the nature of fixed cost.

Step-2:Identify the limiting factor

(a) Where demand is given(b) Where demand is not given (apply the concept of bottle neck)

Step-3:Computation of contribution/limiting factor & give rank.

Step-4:Allotment of resource from highest rank onward. In case of minimum productionequipment for all products 1st allot the limiting resource to fulfill the minimum productioncondition & then allot it on the basis of rank.

Step-5:Prepare the profit statement & determine the best product mix.

Problem 1Universe Ltd. manufactures two products X and Y. It is facing severe competition in the market.The monthly sales potential in units at different selling prices as anticipated by the Sales Mangerare as under:

Product-X______________ Product-YSelling price Sales potential selling price Sales potentialPer unit (Rs.) (in units) per unit (Rs.) (in units)110 5,000 78 30,000108 7,500 77 32,000107 8,000 75 35,000103 8,400 72 40,00096 9,000 69 45,000

The total costs as disclosed by the budgets of the company are as follows:Product X Product-Y

Output and sales per month (units) 5,000 9,000 30,000 45,000Total costs per month (Rs. In lakhs) 5 6.6 18 25.5Labour hours needed per month 20,000 36,000 60,000 90,000

You are required to find out the selling price and units to be sold to earn maximum profit where(a) labour hours are available without any restriction and (b) only 95,000 hours are available.


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Decision Making 3

SolutionWorking Notes:1. Computation of variables cost p.u. and fixed cost (p.m.)

of two products X and Y of Universe Ltd.Products X Y

Rs. Rs.Variable cost per unit 40 50

-----------------------------------------------

units

Rs

000,4

000,60,1.

units

Rs

000,15

000,50,7.

Fixed cost 3,00,000 3,00,000(Total cost-variable cost) (Rs. 5,00,000- (Rs. 18,00,000

Rs. 2,00,000) Rs. 15,00,000)

2. Selling price and sales level of maximum contributionProduct-X Product-Y

Selling contribution units Total selling contribution units total

Price p.u.per unit contribution price p.u (SP-VC) contributionRs. Rs. (Rs. Lakhs) Rs. Rs. (Rs. Lakhs)110 70 5,000 3.5 78 28 30,000 8.4108 68 7,500 5.1 77 27 32,000 8.64107 67 8,000 5.36 75 25 35,000 8.75103 63 8,400 5.292 72 22 40,000 8.8096 56 9,000 5.04 69 19 45,000 8.55

Maximum contribution of two products X and Y are Rs. 5.36 (Lakhs) and Rs. 8.80 (Lakhs) atselling prices Rs. 107 and Rs. 72 respectively.

3. Incremental contribution per labour hour of products X and Y(Refer to working note 2)

Product-X Product YSellingincremental incremental contribution selling incremental incremental contributionPricecontribution labour hrs per hour price contribution labour hrs per hour Per unit per unit

Rs. Rs. Lakhs units4 hrs Rs. Rs. Rs. Lakhs (Units2 hrs) Rs.

(1) (2) (3) (2)/(3)=(4) (5) (6) (7) (6)/(7) = (8)110 3.5 20,000 17.50 78 8.40 60,000 14.00108 1.6 10,000 16.00 77 0.24 4,000 6.00107 0.26 2,000 13.00 75 0.11 6,000 1.83103 (-0.068) 1,600 (-4.25) 72 0.05 10,000 0.5096 (-0.252) 2,400 (-10.50) 69 (-0.25) 10,000 (-2.50)

4. Ranking of products X and Y based on the incrementalContribution per hour as per working note 3

Sl No. selling price Incremental Product RankingContribution per hour

Rs. Rs.1. 110 17.50 X I2. 108 16.00 X II3. 78 14.00 Y III4. 107 13.00 X IV5. 77 6.00 Y V6. 75 1.83 Y VI

7. 72 0.50 Y VII

(a) Statement of selling price and units to earn maximum profit

Change in total cost of a productChange in the output of the product


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Decision Making 4

(No restriction on the availability of labour hours)Products X Y TotalOutput and sales (in units) ofOptimum contribution per month (1) 8,000 40,000(Refer to working note 2)Selling price p.u. (Rs.) 107 72Contribution (Rs./units) (2) 67 22(Refer to working note 2)

Total contribution (Rs.) (1)(2) 5,36,000 8,80,000 14,16,000

Less: Fixed cost (Rs.) 3,00,000 3,00,000 6,00,000(Refer to working note 1) _________ Profit 8,16,000

(b) Statement of selling price and units to earnMaximum profit when only 95,000 labour hours are available

Products selling incremental incremental Labour TotalPrice contribution units hours contribution

Per labour in (Lakhs)Hour

Rs. Rs. Rs.

(1) (2) (3) (4) (5) (3)(5) = (6)

X 110 17.50 5,000 20,000 3.50X 108 16.00 2,500 10,000 1.60Y 78 14.00 30,000 60,000 8.40X 107 13.00 500 2,000 0.26Y 77 6.00 1,500* 3,000* ___0.18

95,000 13.94Less: Fixed costs __6.00Profit 7.94

Balancing figure

Problem 2A Company produces three products from an imported material. The cost structure per unitof the products are as under:Products A B C

Rs. Rs. Rs.Sales value 200 300 250Direct materials 50 80 60Direct wages Rs. 6 per hour 60 120 108Variable overheads 30 60 54

Out of Direct material 80% is of the imported material @ Rs. 10 per kg.

Prepare a statement showing comparative profitability of the three products under thefollowing scenarios:

(i) Imported material is in restricted supply.(ii) Production capacity is limiting factor.(iii) When maximum sales potential of products A and B are 1,000 units each and that of

product C is 500 units for specific requirement, availability of imported material is restrictedto 10,000 kgs per month, how the profit could be maximized?

SolutionWorking Notes:


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Decision Making 5

Value of imported and indigenous material and quantity of imported material consumed P.u..:Products A B CValue of imported material p.u. (Rs.) 40 64 48Value of indigenous material p.u. (Rs.) 10 16 12Quantity of imported material consumed p.u. (Kg.) 4 6.4 4.8

Statement of profitabilityProducts A B CSales value p.u. (Rs.) : (X) 200 300 250Direct material (Rs.) 50 80 60Direct wages (Rs.) 60 120 108

(10 hrs (20 hrs.(18 hrs

Rs. 6) Rs. 6) Rs. 6)Variable overheads (Rs.) __30 __60 __54Total variable cost (Rs.) : (Y) 140 260 222Contribution p.u. (Rs.): (X-Y) 60 40 28

P/V ratio:

100x

S

C30% 13.33% 11.2%

Contribution per kg. Of imported materials (Rs.)(Refer to working note) 15 6.25 5.83Contribution per hour of production (Rs.) 6 2 1.6

(60/10 hrs.) (40/20 hrs)(28/18 hrs)

When imported material is in restricted supply then product A is most profitable one.(ii) Even when production capacity is limited, product A is the most profitable one.

(iii) Statement for maximized profitProducts A B CMaximum sales (units) 1,000 1,000 500Requirement of imported material p.u. (kg) 4 6.4 4.8Total requirement of imported material forMaximum sales (kg.) 4,000 6,400 2,400Contribution per kg. (Rs.) 15 6.25 5.83For maximizing profit 10,000 kg. Of importedMaterial is to be used for manufacturing thoseProducts where contribution per kg is maximum.But 500 units of C must be produced to meetSpecific requirement. Hence the materialUtilized will be (Kg.) 4,000 3,600 2,400No. of units 1,000 562 500

Maximum profit (Rs.) 60,000 22,480 14,000

Problem 3On a turnover of Rs. 20 crores in 1997, a large manufacturing company earned a profit of10% before interest and depreciation, which were fixed. The product mix of the companywas as under:Products Mix % PV ratio Raw materials

To total sales % as % on sales valueP 10 30 40Q 30 20 35R 20 40 50

S 40 10 60

Interest and depreciation amounted to Rs. 150 lakhs and Rs. 77 lakhs respectively due tofluctuation in prices in the international market, the company anticipates that the cost of raw


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Decision Making 6

materials which are imported will increase by 10% during 1997. The company has been ableto secure a licence for the import of raw materials of a value of Rs. 1,023 lakhs at 1997prices. In order to counteract the increase in costs raw materials the company incontemplating to revise its product mix. The market survey report recently prepared indicatesthat the sales potential of each of the products P, Q and R can be increased up to 30% oftotal sales value of 1997. There is no inventory of finished goods or work-in-process in boththe years.

Required:(i) Set an optimal product mix for 1997 and find the profitability.(ii) What percentage increase in overall price is required in1997 to raise the sales value to

maintain the margin of safety at 10%.

SolutionWorking notes(a)

Existing and revised raw material costs

Product Mix % toSales Raw materials Existing cost increased Revised rawTotal sales as % of sale of raw material cost of raw material asValue material % of sales

After 10% valueRise

Rs. Lakhs Rs. Lakhs Rs. LakhsP 10 200 40 80 88 44Q 30 600 35 210 21 38.5R 20 400 50 200 220 55S 40 800 60 480 528 66

2,000 970 1,067

(b) Revised P/V ratio and ranking of productsProduct Existing increase Revised contribution rank

P/V ratio in raw - P/V ratio per Rs. 100 of % material % raw material

over salesValue

P 30 4.0 26.0 59.09 IIQ 20 3.5 16.5 42.86 IIIR 40 5.0 35.0 63.64 IS 10 6.0 4.0 6.06 IV

(c) Maximum sales potential

Rs. In lakhsP 30% Rs. 2,000 =600Q 30% Rs. 2,000 =600R 30% Rs. 2,000 =600S 40% Rs. 2,000 =800

(d) Allocation of raw material whose supply is restricted to Rs. 1,023 lakhs in order of raw materialprofitability.

Product Rank Sales Raw materials Raw material Balance raw


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Decision Making 7

Rs. Lakhs per Rs. 100 required materialLakhs salesRs. Lakhs Rs. Lakhs Rs. Lakhs

1 2 3 4 5 =(34) 6

Balance raw materials 1,023R I 600 55.0 330 693P II 600 44.0 264 429Q III 600 38.5 231 198S IV 300* 66.0 198* Nil

* Balance to be used for the production/ Sales of product S (1980.66 = Rs. 300 lakhs)

(e) Total contribution in 1997 (Rs. In lakhs)Product Sales P/V ratio % Contribution

P 200 30 60Q 600 20 120R 400 40 160S __800 10 __80

_2,000 _420

(f) Computation of fixed costs: Rs. In lakhsPresent turnover 2,000Profit (10% of Rs. 2,000 lakhs) 200Less: Interest 150Depreciation __77Total 227 __227

Net loss __27Rs. In lakhs

Total contribution 420Add: Net loss __27Fixed expenses _447

(i) Optimal mix and profitability for 1997Product Optimum sales Revised P/V Contribution

Rs. In lakhs ratio % Rs. In lakhsP 600 26.0 156Q 600 16.5 99R 600 35.0 210S 300 4.0 __12

2,100 477Less: Fixed costs _447Profit __30

(ii) Required percentage increase in overall price (sales value) in 1997:

Break-even sales:477.

100,2.447.

Rs

xRsRs= Rs. 1,967.92 lakhs

Required sale for 10% margin of safety:

Rs. 1967.9290

100= Rs. 2,186.58 lakhs

Increase in sales value : Rs. 2,186.58 Rs. 2,100 = Rs. 86.58 lakhs

Percentage increase:100,2

10058.86. xRs= 4.12%


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Decision Making 8

Acceptance of an offer and submission of a tender:

Acceptance of an offer: When a firm having surplus capacity receives an offer from a special orexport market, a decision as to whether to accept or not to accept the offer can be taken after theanalysis of the incremental cost and incremental revenue.

Problem 4A co. Ltd. manufactures several different styles of jewellery cases. Management estimatesthat during the third quarter, the company will be operating at 80% of the normal capacity.Because the company desires a higher utilization of plant capacity, the company will considera special order.

The company has received special order inquires from two companies. The first order is fromJCP Co. Ltd., which would like to market a jewellery case similar to one of A co. Ltd. hasoffered A co. Ltd. Rs. 57.50 per jewellery case for 20,000 cases to be shipped by the lastdate of the quarter. The cost data for A Co. Ltd. Jewellery case that would be similar to thespecification of JCP special order are as follows:

Rs.Regular selling price per unit 90

Cost per unitRaw Materials 25Direct labour 0.5 hours @ Rs. 60 30Overhead 0.25 machine hour @ Rs. 40 10Total costs 65

According to the specifications provided by JCP Co. Ltd. the special order case requires lessexpensive raw materials. Consequently the raw materials will only cost Rs. 22.50 per case.Management has estimated that the remaining costs, labour time and machine time will bethe same as for A Co. Ltd. Jewellery case.

The second special order was submitted by K Co. Ltd. for 7,500 Jewellery cases at Rs. 75per case. These jewellery cases, like the JCP cases, would be marketed under K label andhave to be shipped by the last date of the quarter. However, the K jewellery case is differentfrom any jewellery case in the A Co. line. The estimated per unit cost of this case are asfollows:

Rs.Raw materials 32.50Direct labour 0.5 hour @ Rs. 60 30.00Overhead 0.5 machine hour @ Rs. 40 20.00Total costs 82.50

In addition, A Co. ltd. will incur Rs. 15,000 in additional setup costs and will have to purchasea Rs. 25,000 special device to manufacture these cases, this device will be discarded oncethe special order is completed.

The A. Co. Ltd.s manufacturing capabilities are limited to the total hours available. The plantcapacity under normal operations is 90,000 machine hours per year or 7,500 machine hoursper month. The budgeted fixed overhead for the current year amounts to Rs. 21,60,000. Allmanufacturing overhead costs are applied to production on the basis of machine hours at Rs.40 per hour.

A Co. Ltd. will have the entire quarter to work on the special orders. Management does not

expect any repeat sales to be generated from either special order. Company practiceprecludes from subcontracting any portion of an order, when special orders are not expectedto generate repeat sales.


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Decision Making 9

Required: Should A Co. Ltd. accept either Special order? Justify your Solution and show thecalculations.

SolutionStatement showing profits on the acceptance of special orders in 4,500 unutilized hours

(Ref. To working note 1)Alternatives I II

JCP Co. Ltd. K Co. Ltd.Units made 18,000 7,500

Rs.Rs.

Selling price per unit 57.50 75.00Less: Cost per unit 56.50 70.50(Refer to working note 2) ______ _______ Profit per unit __1.00 ___4.50Total profit 18,000 33,750

(18,000 unitsRe. 1) (75,00Rs. 4.50)

Less: Costs of set up and special device __Nil 40,000Net profit/(Loss) 18,000 (6,250)

Note: For special orders allocation of fixed overhead costs are not relevant

Decision:(i) If special order of JCP Co. Ltd. can be bifurcated, the company can supply 18,000 units of

Jewellery cases and can earn additional profit of Rs. 18,000. The remaining 2,000 units oforder cannot be met due to capacity constraint.

(ii) The special order from K Co. ltd. is not acceptable as it results into loss to the extent of Rs.6,250.

Working note:1. Total unutilized hours during the third quarter

Total hours of third quarter 22,500

(7,500 hours3 months)

Hours utilized for 80% operating level 18,000

(22,500 hours80%) _______

Total unutilized hours during the third quarter ___4,500

2. Computation of fixed and variable overhead rateFixed overheads p.a. (Rs.) 21,60,000

Normal capacity hours 90,000Fixed overheads rate per hour (Rs.) 24(Rs. 21,60,000/90,000 hours)Manufacturing overhead application rate per hour (Rs.) 40Therefore, variable overhead rate per hour Rs. (Rs. 40 Rs. 24) 16

3. Cost per unit of the order from JCP Co., Ltd. and K. Co. Ltd.JCP Co. Ltd. K Co. Ltd.Rs. Rs.

Raw material cost per unit 22.50 32.50Direct Labour 30.00 30.00Variable overheads 4.00 8.00

(0.25 hoursRs. 16)(0.5 hrsRs. 16)Total cost per unit 56.50 70.50

__________Problem 5


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Decision Making 10

Unique Products manufactures and sells in a year 20,000 units of a particular product todefinite customers at a price of Rs. 100 per unit. The concern has a capacity to produce25,000 units of the product per annum. To produce beyond 25,000 units per annum, theconcern will have to install a new equipment at a cost of Rs. 15 lakhs. The equipment willhave a life span of 10 years and will have no residual value. There is an offer form a client topurchase 10,000 units of the product regularly at a price of Rs. 90 per unit. The order, ifaccepted, will have to be over and above the existing level of production of 20,000 units.

The cost structure is as under: Per unitRs.

Direct Material 30Direct Labour 20Variable overhead 10Profit 20

During the coming year, it has been estimated that the cost of direct material, as compared to thecurrent year will increase by 10%. Because of certain wage agreement direct labour cost will

increase by 25%. Fixed overheads will increase by 10%. If the new order for 10,000 units isaccepted, fixed overheads will increase further by Rs. 60,000 due to increased administrativecharges.

You are required to analyze whether the concern should accept the order or instead of thattry to secure order for the balance unused capacity, as available now through some salespromotion expenses which will be Rs. 50,000 p.a. Ignore financial charges for the newinvestment.

SolutionComparative cost statement of the three proposals (Based on revised cost structure)

Proposal 1 Proposal 2 Proposal 3Sell 20,000 secure orders for Accept the newUnits only 5,000 additional units order for 10,000

(Unused capacity) additional units && sell 25,000 units sell 30,000 units

Rs. Rs. Rs.Total sales revenue: (A) 20,00,000 25,00,000 29,00,000

(20,000 units (25,000 units (20,000 units

Rs. 100) Rs. 100) Rs. 100) +

(10,000 units

Rs. 90)Direct material 6,60,000 8,25,000 9,90,000


Rs. 33) Rs. 33) Rs. 33)

Direct labour 5,00,000 6,25,000 7,50,000


Rs. 25) Rs. 25) Rs. 25)

Variable overheads 2,00,000 2,50,000 3,00,000


Rs. 10) Rs. 10) Rs. 10)Fixed overheads 4,40,000 4,40,000 4,40,000

(Rs. 4,00,000+ Rs. 40,000)

Add: administrative Charges -- --- 60,000Add: Sales promotion Expenses -- 50,000 ---Depreciation (New equipment) -- -- 1,50,000Total cost : (B) 18,00,000 21,90,000 26,90,000


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Decision Making 11

Profit : (C) = {(A B)} 2,00,000 3,10,000 2,10,000

Analysis: An analysis of the profit figures of M/s Unique products under three proposals clearly showsthat it is maximum under proposals 2. Therefore, it is advisable for the concern to produce andsell 25,000 units @ Rs. 100/- per unit and utilize its full production capacity.

_____________Problem 6

Capacity unit cost unit selling price

Rs. Rs.6,000 80 1007,000 75 978,000 74 959,000 72

10,000 71

The firm is operating at 8,000 units capacity and has received an order for 2,000 units from an

export market at a price of Rs. 70 per unit. Advise the firm as to whether the export order shouldbe accepted or not.

SolutionApparently the unit cost at 9,000 and 10,0000 units capacity is Rs. 72 and Rs.71 respectivelyand since the export order is at Rs. 70 per unit, the order is not profitable. But this is a wrongapproach. Let us tabulate the figure again and see the result.Capacity Unit Total Incremental unit Total sales Incremental

Cost cost cost price value revenueRs. Rs. Rs. Rs. Rs. Rs.

6,000 80 4,80,000 100 6,00,000

7,000 75 5,25,000 45,000 97 6,79,000 79,0008,000 74 5,92,000 67,000 95 7,60,000 81,0009,000 72 6,48,000 56,00010,000 71 7,10,000 62,000

At 8,000 level of output the total sales revenues is Rs. 7,60,000 and the total cost is Rs. 5,92,000leaving a profit of Rs. 1,68,000. The fact that this level of output leaves a profit means that thefixed expenses have been recovered already. Hence we have to take only the incremental costfor further levels of output. For an additional sales of 2,000 units the incremental cost is Rs.7,10,000 Rs. 5,92,000 = Rs. 1,18,000. The cost per unit, therefore, is Rs. 1,18,0002,000 units= Rs. 59 for which the price quoted is Rs. 70 per unit. The offer is therefore acceptable.

Submission of tender: For submitting tenders also the incremental cost and incrementalrevenue approach is useful. Considering the above example, if the firm operates at 8,000 level ofoutput and quotations are to be given, any price quotation above the unit incremental cost of Rs.59 would be profitable.

Problem 7All Play and Nowork Ltd. are specialists in the manufacture of sports goods. They manufacturecroquet mallets but purchase the wooden balls, iron arches and stakes required to complete acroquet set.Mallets consist of a head and handle. Handles use 1.5 board feet per handle at Rs. 40 per boardfoot. Spoilage loss is negligible for the manufacture of handles.Heads frequently split and create considerable scrap. A head requires 0.20 board feet of highquality lumber costing Rs. 70 per board foot. Spoilage normally works out to 20% of the


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Decision Making 12

completed heads. 4% of the spoiled heads can be salvaged and sold as scrap at Rs. 10 perspoiled head.

In the department machining and assembling the mallets, 12 men work 8 hours per day for 25days in a month. Each worker can machine and assemble 15 mallets per uninterrupted 50minutes time frame. In each 8 hours working day, 15 minutes are allowed for coffee break, 8minutes on an average for training and 9 minutes for supervisory instruction. Besides 10% ofeach day is booked as idle time to cover checking in and checking out changing operations,getting materials and other miscellaneous matters. Workers are paid at a comprehensive rate ofRs. 6 per hour.

The department is geared to produce 40,000 mallets per month and the monthly expenses of thedepartment are as under:

Rs.Finishing and painting of the mallets 50,800Lubricating oil for cutting machines 300Depreciation for cutting machine 700

Repairs and maintenance 100Power to run the machines 200Plant Managers salary 2,700Other overheads allocated to the department 1,20,000

As the mallets are machined and assembled in lots of 500, prepare a total cost sheet for one lotand advise the management on the selling price to be fixed per mallet in order to ensure aminimum 20% margin on the selling price.

SolutionAll play and Nowork Ltd.

Cost Sheet of one lot of 500 Croquet Mallets

Rs. Rs. Rs.Direct Materials:

Handles (1.5 feet500 unitsRs. 40) 30,000

Heads (1.205000.20Rs. 70) 8,400

(Refer to working note 1)Less: scrap recovery

(4%100Rs. 10) ___40 8,360 38,360

Direct labour:

500120

6..8x

xRshrs(Refer to working note 2) 200

Prime cost 38,560

Factory & other overheads:VariableFinished & painting 635

500

000,40

000,50.x

Rs(Ref. To working note 3)

Fixed

500

000,36

000,24,1.x

Rs(Ref. To working note 4) 1,722

_______Total cost _40,917

Price quotation:

Cost per mallet

units

Rs

500

917,40.81.834

Add: Profit 25% on cost 20.458


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Decision Making 13

(20% margin on selling price means 25% on cost) ______ selling price 102.29

Working notes:1. Since 20% of completed heads are spoiled, output of 1 unit requires input of 1 + 0.20 = 1.20

units; so, total heads processed: 1.20500 = 600, of which spoiled heads are 100.

2. Total time in a day: 860 480 minutes

Less: Idle time 48 minutesCoffee break 15 minutesInstructions 9 minutesTraining 8 minutes 80 minutes

Productive time per day: 400 minutes

Therefore, mallets to be produced per man per day:

1550

400x = 120 units

3. Finishing and painting overheads are assumed to be variable for the production of 40,000mallets.

4. All the other expenses are fixed and are to be absorbed by 36,000 mallets of monthlyproduction. Since mallets are produced at the rate of 120 mallets per man day, so total

monthly production will be: 120 units12 men25 days = 36,000 mallets.

_______________

Problem 8Somesh of Agra presently operates its plant at 80% of the normal capacity to manufacture aproduct only to meet the demand of Government of Tamil Nadu under a rate Contract.

He supplies the product for Rs. 4,00,000 and earns a profit margin of 20% on sales realizations.Direct cost per unit is constant.

The indirect costs as per his budget projections are:Indirect costs 20,000 units 22,500 units 25,000 units

(80% capacity) (90% capacity) (100% capacity)Rs. Rs. Rs.

Variable cost 80,000 90,000 1,00,000Semi-variable 40,000 42,500 45,000Fixed cost 80,000 80,000 80,000

He has received an export order for the product equal to 20% of its present operations.Additional packing charges on this order will be Rs. 1,000.

Arrive at the price to be quoted for the export to give him a profit margin of 10% on the exportprice.

SolutionWorking notes:1. Direct cost per unit Rs.

Selling price per unit 20(Rs. 4,00,000/20,000 units)Less: profit margin 4

(20%Rs. 20) ____

Total cost 16Less: Indirect costs __10(Rs. 2,00,000/20,000 units)


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Decision Making 14

Direct cost per unit ___6

2. Statement of differential cost for 4,000 units(20% of 20,000 units)

Present proposed DifferentialProduction production cost for

20,000 24,000 4,000units units unitsRs. Rs. Rs.

Direct cost @ Rs. 6/- p.u. 1,20,000 1,44,000 24,000Indirect cost:Variable @ Rs. 4/- p.u. 80,000 96,000 16,000Semi variable 40,000 44,000 4,000Fixed 80,000 81,000 1,000Total 3,20,000 3,65,000 45,000

Computation for the price to be quoted for the export order of 4,000 units.

Rs.Differential cost 45,000(Ref. To working note 2)Add: Profit 5,000(10% of export price or 1/9th of cost)

_______Price to be quoted _50,000

Export price per unit; Rs. 12.50(Rs. 50,000/4,000 units)

___________

Problem 9A company can produce and sell at its maximum capacity 20,000 units of a product. The sale ofprice is Rs. 100. The present sales 15,000 units. To produce over 20,000 units and up toanother 10,000 units some balancing equipments are to be installed at a cost of Rs. 10 lakhs andthe same will have a life span of 10 years.

The current cost structure is as under:Direct material 30% of sales valueDirect labour 20% of sales valueVariable overheads Rs. 20 per unitProfit Rs. 15 per unit

The present cost is estimated to go up due to price escalation as under:10% in Direct material from present level of 30%25% in Direct Labour from present level of 20%Rs. 50,000 in Fixed overheads per year.

There is a concrete proposal from a party to take 10,000 units additionally over the present levelof output on a long-term basis at a unit price of Rs. 90. Apart from the investment of Rs. 10lakhs, as shown above, the fixed overheads will increase by Rs. 50,000 due to additionaladministrative expenses.

The Company is in a dilemma as to whether to accept the order for 10,000 units or to use thepresent unused capacity of 5,000 units for which there will be additional selling expenditure ofRs. 50,000.

Ignore financing charges and give your recommendation.


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Decision Making 15

SolutionWorking Note: Rs.Fixed overheads:Present sales value: (A) 15,00,000

(15,000 unitsRs. 100)

Direct Materials 4,50,000(30% of sale value)Direct labour 3,00,000(20% of sale value)Variable overheads 3,00,000(Rs. 20 per unit) ________ Total variable costs: (B) 10,50,000Contribution: (C) : (A) (B) 4,50,000Profit: (D) 2,25,000

(15,000 units15) ________

Fixed overheads: (C) (D) 2,25,000(current level)

Add: Additional fixed overheads due to price escalation __50,000Total fixed overheads 2,75,000

Statement of profitability for various alternativesAlternatives I II III IV

Rejecting the proposal rejecting the proposals Accepting the Accepting theFor the purchase of for the purchase of proposal of proposal of

10,000 units & 10,000 units from a the party to take party to takeContinuing with party and attaining 10,000 units @ 10,000 units @Present level of the maximum capacity Rs. 90 p.u. by Rs. 90 p.u. by

Sales only by incurring additional installing a installing aSelling expenditure balancing equipment balancing

& Continuing with equipment &Present level of attaining sale of

Sales maximum availableCapacity by incurring

Additional sellingExpenditure

Sales (Units) 15,000 20,000 25,000 30,000Rs. Rs. Rs. Rs.

Sales value: (A) 15,00,000 20,00,000 24,00,000 29,00,000

(15,000Rs. 100) (20,000Rs. 100) (15,000Rs. 100 (20,000Rs. 100

+ 10,000Rs. 90) + 10,000Rs. 90) + (10,000Rs. 90)

Variable costs:Direct materials 4,95,000 6,60,000 8,25,000* 9,90,000*(33% of sales value)Direct Labour 3,75,000 5,00,000 6,25,000* 7,50,000*(25% of sale value)variable overheads 3,00,000 4,00,000 5,00,000 6,00,000(@ Rs. 20 per unit) _________ total Variable costs: (B) 11,70,000 15,60,000 19,50,000 23,40,000Fixed costs:(Ref. To working note) 2,75,000 2,75,000 2,75,000 2,75,000Additional sellingExpenditure --- 50,000 --- 50,000Deprecation for

Balancing equipment --- --- 1,00,000 1,00,000Additional administrativeExpenses ______--- --- 50,000 50,000Total fixed costs: (C) 2,75,000 3,25,000 4,25,000 4,75,000Total costs D: [(B)+(C)] 14,45,000 18,85,000 23,75,000 28,15,000


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Profit : (A) (D) 55,000 1,15,000 25,000 85,000

* Note: For computing the material and labour cost under alternative III & IV the notional saleprice of Rs. 100 is taken for additional 10,000 units.

Recommendations: Alternative II is the best as it gives maximum profit._________

Problem 10R. Ltd. will produce 3,00,000 kgs. Of S and 6,00,000 kgs. Of Y from an input of 9,00,000 kgs. Ofraw material Z.

The selling price of S is Rs. 8 per kg. And that of Y is Rs. 6 per kg.Processing costs amount to Rs. 54 lakhs per month as under: Rs.Raw material Z 9,00,000 kgs. at Rs. 3 per kg. 27,00,000Variable processing costs 18,00,000Fixed processing costs 9,00,000

Total 54,00,000

There is an offer to purchase 60,000 kgs of Y additionally at a price of Rs. 4 per kg. The existingmarket for Y will not be affected by accepting the offer. But the price of S is likely to bedecreased uniformly on all sales.

Find the minimum reduced average price for S to sustain the increased sales.

SolutionSince S & Y are produced simultaneously from an input of raw material Z, therefore whenadditional 60,000 kgs. of Y will be produced then 30,000 kgs. of S will also be producedsimultaneously. The input of material Z required for these additional 60,000 kgs of Y and 30,000

kgs. of S will be 90,000 kgs. of material Z. Hence the cost of processing 90,000 kgs. of materialwill be as follows:

Rs.Cost of raw material Z 2,70,000

(90,000 kgs.Rs. 3)

Variable processing cost 1,80,000

(90,000 kgs.Rs. 2) ________

Total cost of processing 4,50,000Less: Sales revenue from 60,000 kgs. of Y 2,40,000

(60,000 kgsRs. 4) _________

Balance cost to be recovered 2,10,000

Current sales revenue from the sale of 3,00,000 kgs. of S 24,00,000(3,00,000 kgs. Rs. 8)

total sales revenue to be earned from the sale of S 26,10,000(3,00,000 kgs + 30,000 kgs.)

Hence, minimum price per kg. Of S to recoverRs. 26,10,000 from the sale of 3,30,000 kgs. of S 7.91(Rs. 26,10,000/3,30,000 kgs.)

______________

Make or Buy decision: Very often management is faced with the problem as to whether a partshould be manufactured or it should be purchased from outside market. Under such

circumstances two factors are to be considered:

a) Whether surplus capacity is available, andb) The marginal cost.


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Decision Making 17

Problem 11 The total cost of a manufactured component is as under:Prime cost Rs. 15 Fixed overhead Rs. 4Variable overhead Rs. 7 Total cost Rs. 26

The same part is available in the market at Rs. 23. Should the firm make it or buy it.

SolutionIf surplus capacity is available and will remain idle if the component is bought, the out of pocketexpenses will be Rs. 23 per unit. Re. 1 more than the variable (relevant) cost of makingcomponent, which is Rs. 22 (Rs. 15 + Rs. 7). Hence, it is economical to make it. However, if thefirm is utilizing or can utilize the capacity in making some other part which contributes, say Rs. 4per unit, the effective cost of buying the component will be Rs. 19 (Rs. 23 less Rs. 4 contributionfrom other product). In that case, it would be economical to buy the component at Rs. 23 per unitfrom outside. The relevant computations for taking decision may be as follows:

Make Per unit cost Buy and useBuy and leave capacity for

Capacity idle other productRs. Rs. Rs.

Cost of making/buying (22) (23) (23)Contribution from other production __--__ __--__ ___4Net relevant cost __(22) __(23) __(19)

____________________

Problem 12

Perfect product Ltd. is currently buying a component from local supplier at Rs. 15 each thesupply is tending to be irregular. Two proposals are under consideration:

1. Buy and install a semi automatic machine for manufacturing this component, which wouldinvolve an annual fixed cost of Rs. 9 lakhs and a variable cost of Rs. 6 per manufacturedcomponent.

2. Buy and install an automatic machine for manufacturing this component, incurring an annualfixed cost of Rs. 15 lakhs and a variable cost of Rs. 5 per manufactured component.

Determine with necessary computations:(1) The annual volume required, in each case, to justify a switch over from outside purchase to

own manufacture.

(2) The annual volume required, to justify selection of the automatic machine instead of thesemi-automatic machine.

(3) If the annual requirement of the coming year is expected to be 5,00,000 nos. and thevolume is expected to increase rapidly thereafter, would you recommend the automatic orsemi-automatic machine. Justify your recommendation.

Solution(1) Proposal 1 Proposal 2

semi-automatic automaticmachine machine

Rs. Rs.Purchase cost per unit for the component now being bought 15 15


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Decision Making 18

Less: unit variable cost for won manufacture __6 __5Unit contribution from own manufacture 9 10Total annual fixed cost to be recouped 9,00,000 15,00,000No. of units required to fully recover the amount 1,00,000 Nos. 1,50,000 Nos.

These figures show that an annual volume of over 1,00,000 Nos. of the component will justifyown manufacture on the semi-automatic machine, instead of purchase from outside.

To justify the installation of the automatic machine, the quantity required is an annual volume ofover 1,50,000 Nos.

(2) Incremental annual fixed cost if automatic machine is chosen: Rs. 6,00,000Saving in unit variable cost by choosing the automatic machine Re. 1Production volume required to recover the additional annual 6,00,000 Nos.Fixed costs through saving in unit variable cost.

For annual requirements of over 6,00,000 units of the components, the automatic machine will be

more economical as compared to the semi-automatic machine.

(3) if the annual requirement is 5,00,000 units, the semi automatic machine is to be preferred, as itwould involve a lower total cost per unit of the component, as indicated below:

semi-automatic automaticRs. Rs.

Total variable costs:5,00,000 units @ Rs. 6 and Rs. 5 respectively 30,00,000 25,00,000Total fixed costs 9,00,000 15,00,000Total costs 39,00,000 40,00,000Total cost per unit 7.80 8.00

However, the annual requirement is expected to increase rapidly beyond 5,00,000 units; as soonas it is 6,00,000 units the semi-automatic machine will become more expensive as compare tothe automatic machine. Then the need for installing the automatic machine will arise which maybe within a very short period after commissioning the semi-automatic machine. Replacement ofthe semi-automatic machine by an automatic machine may then become costly, not onlybecause of the loss that may arise on the semi-automatic machine but also by possible a higherprice of the automatic machine. The management may therefore, install an automatic machineimmediately.

__________

Problem 13Agrocaps Ltd., in manufacturing agricultural machinery, is preparing its annual budget for the

coming year. The company has a metal pressing capacity of 20,000 hrs, which will beinsufficient for manufacture of all requirements of components A, B, C and D.

The company has the following choices:(i) Buy the components entirely from outside suppliers.(ii) Buy from outside suppliers and/or use a partial second shifts.

The data for the current year are given below:

Standard production cost per unitComponent A B C D

Rs. Rs. Rs. Rs.Variable cost:

Direct Materials 37 27 25 44Direct Wages 10 8 22 40Direct expenses 10 20 10 60


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Decision Making 19

Fixed overheads __5 __4 _11 _20Total production cost p.u. _62 _59 _68 164Requirements in units 2,000 3,500 1,500 2,800

Direct expenses relate the use of the metal presses, which cost Rs. 10 per hour, to operate.Fixed overheads are absorbed as a percentage of direct wages.

Supply of all or any part of the total requirement can be obtained at following prices, eachdelivered to the factory:

Component Rs.A 60B 59C 52D 168

Second shift operations would increase direct wages by 25% over the normal shift and fixed

overhead by Rs. 500 for each 1,000 (or part thereof) second shift hours worked.

You are required to present, with calculations:(a) Which component, and in how much quantities should it be manufactured in the 20,000 hours

of press time available?(b) Whether it would be profitable to make any of the balance of components required on a

second shift basis instead of buying them from outside suppliers.

Solution(a) Working notes:

(i) Process hours requiredComponent A B C D

Rs. Rs. Rs. Rs.Direct expenses per unit 10 20 10 60No. of press hours per unit,Direct expenses per press hour being Rs. 10 1 2 1 6

(ii) Marginal cost of production per unit vs. bought out prices per unitComponent A B C D

Rs. Rs. Rs. Rs.Marginal (Variable) Costs

Direct material 37 27 25 44Direct wages 10 8 22 40

Direct expenses 10 20 10 60Marginal cost per unit: (A) 57 55 57 144Bought out price: (B) 60 59 52 168Excess of bought out price over marginal ___ ___ ___ ___ Cost: {(B-A)} 3 4 (5) 24Press hours per unit __1 ___2 __1 __6Excess of bought out price per unit of limiting __3 __2 _(5) _4Factor (i.e. press hour).

The bought-out price for component C is lower by Rs. 5 than the marginal cost of production andso it should be purchased from outside.

In case the remaining components A, B and D are bought, their ranking in terms of loss per unitof limiting factors (Press hour) would be D (highest loss per unit), A and B. The capacityavailable should, therefore, be deployed for making D first and then A and thereafter B.


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Decision Making 20

Components and their quantities to be manufactured in 20,000 hours of press time available(Singe shift operation)

HoursAvailable capacity for metal pressing 20,000

First, produce D hours required (2,800 units 6 hours) 16,800

Balance hours available 3,200

Second produce A hours required (2,000 units1 hour) 2,000

Balance hours available 1,200

Third, produce B, for the balance hours available (600 units2hours) 1,200

Balance hours available ___Nil

So, in 20,000 hours of press time available, all the requirements of components D and A andonly 600 units of component B can be manufactured. The balance requirement of component Bi.e. 2,900 (3,500-600) units of component will have to be bought out or manufactured in thesecond shift.

(b) Since the purchase price of Component C (i.e. Rs. 52) is lower than the marginal cost of

manufacturing (i.e. Rs. 57) in even single shift, it will not be profitable to make it hence it shouldbe purchased from outside.

Now it is to be seen whether 2,900 units of B should be produced in the second shift or boughtfrom outside. The comparative position is given below:

Cost of producing 2,900 units of components B in second shift Rs.Variable cost per unit on single shift basis 55.00Add: Increase in direct wages per unit __2.00Variable cost per unit 57.00

Total Variable cost for 2,900 units, (2,900 unitsRs. 57) 1,65,300

Additional fixed cost:

Hours required for 2,900 units of B (2,900 units2 hours) = 5,800 hrs.

Extra fixed cost for 5,800 hours at Rs. 500 for every 1,000 hours(or part thereof) 3,000Total cost for producing 2,900 units of B in second shift: (A) 1,68,300

Bought outside price for 2,900 units of B will be 2,900 unitsRs. 59: (B) 1,71,100

Disadvantage in buying: (A B) (2,800)

Since the cost of manufacturing balance quantity for component B i.e. 2,900 in second shift isless by Rs. 2,800, it is profitable to make it on a second shift basis instead of buying it fromoutside suppliers.

______________

Problem 13A company manufacturing a highly successful line of cosmetics intends to diversify the productline to achieve fuller utilization of its plant capacity. As a result of considerable research madethe company has been able to develop a new product called EMO.

EMO is packed in tubes of 50 gram capacity and is sold to the wholesalers in cartons of 24 tubesat Rs. 240 per carton. Since the company uses its spare capacity for the manufacture of EMO,no additional fixed expenses will be incurred. However the cost accountant has allocated ashare of Rs. 4,50,000 per month as fixed expenses to be absorbed by EMO as a fair share of the

companys present fixed costs to the new product for costing purposes.

The company estimates the production on sale of EMO at 3,00,000 tubes per month and on thebasis the following cost estimates have been developed:


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Decision Making 21

Rs. per cartonDirect Materials 108Direct wages 72Overheads 54Total costs 234

After a detailed market survey the company is confident that the production and sales of EMOcan be increased to 3,35,000 tubes per month and ultimately to 4,50,000 tubes per month.

The company at present has a capacity for the manufacture of 3,00,000 empty tubes and thecost of the empty tubes if purchased from outside will result in a saving of 20% in material and10% in direct wages and variable overhead costs of EMO. The price at which the outside firm iswilling to supply the empty tubes is Rs. 1.35 per empty tube. If the company desires tomanufacture empty tubes in excess of 3,00,000 tubes, a new machine involving an additionalfixed overheads of Rs. 30,000 per month will have to be installed.

Required:

(i) State by showing your workings whether the company should make or buy the emptytubes at each of the three volumes of production of EMO namely, 3,00,000; 3,50,000 and4,50,000 tubes.

(ii) At which volume of sales will it be economical for the company to install the additionalequipment for the manufacture of empty tubes?

(iii) Evaluate the profitability on the sale of EMO at each of the aforesaid three levels ofoutput based on your decision and showing the cost of empty tubes as a separateelement of cost.

Solution

(i) Working Notes:Rs.

(1) Overheads for one carton i.e. 24 tubes 54Therefore, per tube overheads: (Rs. 54/24 tubes) 2.25Fixed overheads allocated for 3,00,000 tubes: Rs. 4,50,000

Rs. 4,50,000Per tube fixed overheads: ------------------------- = Rs. 1.50

3,00,000 tubes

Therefore, variable overheads, per tube {Rs. 2.25 Rs. 1.50} = Re. 0.75Rs.

(2) Direct wages per carton 72Therefore, direct wages per tube: (Rs. 72/ 24 tubes0 3

(3) Direct materials per carton 108Therefore, direct materials per tube: (Rs. 108/24 tubes) 4.50

(4) Cost of making one empty tube:

Cost Costs in Cost of Cost per tube

Per tube of respect of empty of EMO withoutEMO empty tube tube empty tubeRs. Rs. Rs Rs.

Direct Materials 4.50 20 0.90 3.60


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Decision Making 22

Direct wages 3.00 10 0.30 2.70Variable overheads 0.75 0.075 0.675

8.25 1.275 6.975

Cost of manufacturing/ buying of 300,000 empty tubes of EMO

Empty tube if empty if emptyCost tubes are tubes are

Made purchasedRs. Rs. Rs.

Direct materials 0.90 2,70,000 ---Direct wages 0.30 90,000 ---Variable overheads 0.075 22,500 ---Purchase price 1.35 --- 4,05,000

_______ ________Total 3,82,500 4,05,000

Since manufacturing capacity is available for the manufacture of 3,00,000 empty tubes at a costof Rs. 3,82,500 whereas the total cost of purchase of tubes is higher, i.e., Rs. 4,05,000, thecompany should manufacture the empty tubes for a production volume of 3,00,000 EMO tubes.

Beyond 3,00,000 empty tubes, the company has to install a new machine involving a totaladditional fixed overheads of Rs. 30,000. the cost of making and buying the additional tubes50,000 and 1,50,000 units of empty tubes will be as under:

Additional empty tubes________

50,000 tubes 1,50,000 tubesPer tube Make Buy Make BuyRs. Rs. Rs. Rs. Rs.___

Direct Materials 0.90 45,000 1,35,000---Direct wages 0.03 15,000 45,000 ---Variable overheads 0.075 3,750 11,250 ---Additional overheads 30,000 30,000 ---Purchase price 1.35 --- 67,500 --- 2,02,500

______ _______ ________ ________93,750 67,500 2,21,250 2,02,500

The above statement shows that the cost of buying additional empty tubes at both the levels islower than the cost of their manufacture. Therefore, if the company increases production to3,50,000 tubes of EMO, 3,00,000 tubes should be made in the factory and additional 50,000tubes should be purchased at Rs. 67,500.

If the company increases production to 4,50,000 tubes of EMO, 3,00,000 empty tubes should bemade in the factory and additional 1,50,000 tubes should be purchased at a cost of Rs. 2,02,500.

(iii) Additional fixed overheads to be incurred on a new machine: Rs. 30,000, savings per unit ifempty tubes are made in the factory instead of buying: Rs. 135 Rs. 1.275 = Re. 0.75 .Minimum additional quantity of empty tubes to be made to recover the additional fixed costs:

Rs. 30,000------------------ = 4,00,000 empty tubes.Rs. 0.075


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Decision Making 23

Thus the company should sell 3,00,000 + 4,00,000 = 7,00,000 tubes of EMO per month towarrant justification for the installation of the new machine for the manufacture of empty tubes.

(iii) Evaluation of the profitability on sale of EMO at the three levels

per tube 3,00,000 tubes 3,50,000 tubes 4,50,000 tubesRs. Rs. Rs. Rs._______

Sales (Rs. 240/ 24 tubes) 10 30,00,000 35,00,000 45,00,000Direct materials 3.60 10,80,000 12,60,000 16,20,000Direct wages 2.70 8,10,000 9,45,000 12,15,000Variable overheads 0.675 2,02,500 2,36,250 3,03,750Empty tubes made 1.275 3,82,500 3,82,500 3,82,500Empty tubes purchased 1.35 --- 67,500 2,02,500

________ _________ _________Total costs 24,75,000 28,91,250 37,23,750Profit 5,25,000 6,08,750 7,76,250

__________

Problem 14A firm needs a component in an assembly operation. If it wants to do the manufacturing itself, itwould need to buy a machine for Rs. 4 lakhs, which would last for 4 years with no salvage value.Manufacturing costs in each of the 4 years would be Rs. 6 lakhs, Rs. 7 lakhs, Rs. 8 lakhs and 10lakhs respectively. If the firm had to buy the component from a supplier the component wouldcost Rs. 9, 10, 11 lakhs and Rs. 14 lakhs respectively in each of the 4 years. However, themachine would occupy floor space with could have been used for another machine. This lettermachine could be hired at no cost to manufacture an item, the sale of which would produce net

cash flows in each of the 4 years of Rs. 2 lakhs; it is impossible to find room for both themachines and there are no other external effects. The cost of capital is 10% and PV factor foreach of the 4 years is 0.909, 0.826, 0.751 and 0.683 respectively. Should the firm make thecomponent or buy from outside

SolutionEvaluation of Make or Buy proposal

Year Present value When the component When the componentFactor at 10% is manufactured is bought

Cash outflow Present value Cash outflow Present value(Capital cost, of cash outflows (cost of buying)

ManufacturingCost + opportunity

Cost0 1.000 4 4.000 --- ---1 0.909 6+2 7.272 9 8.1812 0.826 7+2 7.434 10 8.2603 0.751 8+2 7.510 11 8.2614 0.683 10+2 _8.196 14 _9.562

34.412 34.264

Saving in buying: Rs. 34.412 lakhs Rs. 34.264 lakhs = Rs. 0.148 lakhs

Thus it is beneficial to buy the component from outside.


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Decision Making 24

Note: The loss of Rs. 2 lakhs cash inflow for each of the 4 years due to inability of the firm tooperate another machine when it manufactures the component is to be treated as an opportunitycost.

__________

Problem 15Product A takes five hours to produce on a particular machine and it has a selling price of Rs.50 and a marginal cost of Rs. 35.

On the same machine, another product B can be made at two hours at a marginal cost of Rs. 5per unit.Suppliers price of product B is Rs. 10 per unit.

Assuming that machine hour is the key factor, advise whether product B Could out ormanufactured.

Solution Rs.Selling price per unit of product A 50Less: Marginal cost per unit __35Contribution per unit 15Contribution per hour of product A 3(Rs. 15/5 hours)

Since one unit of product B needs 2 hours, therefore if a unit of B is produced, then the

contribution lost by not producing A = 2 hoursRs. 3 = Rs. 6

Real cost of producing one unit of product B

Rs.Marginal cost per unit 5Add: Contribution lost per unit __6Total cost of producing a unit of product B __11

As the suppliers price per unit of product B is Rs. 10 and that of producing in the factory is Rs.11, therefore it is suggested that it is better to buy product B from outside.

_________

Problem 16A machine manufactures 10,000 units of a part at a total cost of Rs. 21 of which Rs. 18 isvariable. This part is readily available in the market at Rs. 19 per unit.

If the part is purchased from the market then the machine can either be utilized to manufacture acomponent is same quantity contributing Rs. 2 per component or it can be hired out at Rs.21,000.Recommend which of the alternative is profitable.

Solution1st Alternative(10,000 units of the part are manufactured internally).Variable cost of 10,000 units@ Rs. 18 p.u. (Rs.) 1,80,000

2

nd

Alternative(10,000 units of the part are purchased from the market and the machine is utilized tomanufacture 10,000 units of a component contributing Rs. 2/- per unit)purchase cost of 10,000 units@ Rs. 19/- p.u. (Rs.) 1,90,000


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Decision Making 25

Less: Contribution received on the utilization of machine time

10,000 unitsRs. 2 __20,000

1,70,000

3rd Alternative(10,000 units of the part are purchased from outside and the machine time is hired out at Rs.21,000)Purchase cost of 10,000 units@ Rs. 19/- p.u. (Rs.) 1,90,0000Less: Rent received on hiring out the machine __21,000

Important note:In this problem fixed cost is not relevant for decision making, therefore it has been ignored.

RecommendationOut of the above three alternatives, 3rd alternative is the best, as the cost of 10,000 required units

under it is the lowest.___________

Export vs. local sale decision:

When the firm is catering to the needs of the local market and surplus capacity is still available, itmay think of utilizing the same to meet export orders at price lower than that prevailing in thelocal market. This decision is made only when the local sale is earning a profit, i.e., where itsfixed expenses have already been recovered by the local sales. In such cases, if the export priceis more than the marginal cost, it is preferable to enter the export market. Any reduction in theprice prevailing in the local market to fulfill surplus capacity may have adverse effect on the

normal local sales. Dumping in the export market at a lower price will not, however, have anysuch adverse effect on local sales.

Problem 17Perfect Pistons Ltd. Produces 60,000 pistons per annum for its percent company perfect MotorsLtd. The pistons are sold to Perfect Motors at Rs. 200 per unit. The variable cost per piston isRs. 180. The animal fixed cost of perfect pistons Ltd. Is Rs. 15 lakhs and it is currently operatingat 60% capacity.

The company desires to respond to an export enquiry for 30,000 pistons of the type it is currentlymanufacturing. The companys aim is to improve capacity utilization and avoid loss.

You have to take note of the following benefits that will accrue to the export transaction, whiledetermining the FOB price to be quoted.

(i) Export incentive by way of cash assistance at 10% of FOB value of exports.(ii) Reimbursement of excise duty on manufacturing inputs by way of 5% drawback of duty

on FOB value of exports.(iii) Entitlement of import license to the extent of 10% on FOB value of exports. The import

license can either be sold at a premium of 100% or it can be utilized to import certaincritical auto components what will yield a 30% profit on cost.

Recommend the bare minimum price that the company should quote, in order to break evenassuming:

(a) it sells the import license in the market.(b) it imports component against the licence and sells them for profit.

SolutionPresent Operating Results of Perfect Piston Ltd.


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Decision Making 26

Contribution per piston = selling price variable cost= Rs. 200 Rs. 180 = Rs. 20

Total Annual contribution = (60,000 Rs. 20) =Rs. 12 lakhs

Less: Annual Fixed costs __Rs. 15 lakhsProfit (Loss) Rs. (3 lakhs)

Increase in capacity utilization and the resultant and export sales should enable the company torecover this loss.

(a) COMPUTATION OF RARE MINIMUM PRICE TO BREAK - EVENWHEN IMPORT LICENCE IS SOLD IN THE MARKET

Variable cost per piston Rs. 180.00Add: Amount per piston towards recovering the present loss(Rs. 3,00,000/ Rs. 30,000) ____10.00Cost per piston 190.00Less: Realization through export benefits:Cash Assistance 10% on FOB

Duty Draw back 5% on FOBPremium on Licence 10% on FOB

25% on FOB

i.e., 20% * of the cost per piston of Rs. 190 = __38.00Hence, bare minimum FOB price to be quoted comes to 152.00

(b) COMPUTATION OF BARE MINIMUM PRICE TO BREAK EVEN WHEN IMPORTLICENCE IS USED TO IMPORT AUTO COMPONENTS AND SELL THEM FOR PROFITCost per piston (as per (a) above) Rs. 190.00Less: Realization through export benefitsCash Assistance 10% on FOB

Duty Drawback 5% on FOBProfit on sales of imports30% of 10% of FOB 3% on FOB

18% on FOB

i.e., 15.25% * of cost per piston = Rs. 190 15.25% ___29.89

Bare minimum FOB price to be quoted 161.02

Alternative solution: (Assuming x to be the bare minimum F.O.B. Price)Rs.

Total variable cost for 30,000 pistons @ Rs. 180 54,00,000Add: Loss to be recovered __3,00,000Total 57,00,000

(a) The following equation can be formed and solved for determining the price when importlicence is sold in the market.

30,000x= Rs. 57,00,000 {(30,000x 0.10) + (30,000x 0.05) +(30,000x 0.10)}

or, 30,000 x = Rs. 57,00,000 7,500xor, x = Rs. 152

Bare minimum F.O.B. price to be quoted is Rs. 152 per piston.

(b) The following equation can be formed and solved for determining the price when import

licence is used to import auto-components and sell them for profit.

30,000x = Rs. 57,00,000 {(30,000x 0.10) + (30,000x 0.05) + (30,000x 0.03)}

or, 30,000x = Rs. 57,00,000 5,400xx = Rs. 161.02


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Bare minimum F.O.B. price to be quoted is Rs. 161.02 per piston.

Problem 18A firm gives the following data:Selling price Rs. 6 p.u. Fixed expenses Rs. 15,000Total cost Rs. 5 p.u. Marginal cost Rs. 4 p.u.Local sales 15,000 units Capacity of the plant 20,000 units

Export order received for 3,000 units at Rs. 4.50 p.u. Advise whether to accept the export orderor not.

SolutionBreak-even point = ----------------------------------

=4.6.

000,15.

RsRs

Rs

=

2.

000,15.

Rs

Rs

= 7,500 units

Since fixed expenses are recovered at this level of output, any price above the margin costs willfetch additional profit. So the export-selling price of Rs. 4.50 will fetch an additional profits of Rs.1,500 as under:

3,000 units(Rs. 4.50 Rs. 4.00) = Rs. 1,500

Since the goods are sold in the export market, it will not have any adverse effect on the localselling price of Rs. 6 per unit.

_________

Problem 19X Ltd. having an installed capacity of 1,00,000 units of a product is currently operating at 70%utilization. At current levels of input prices, FOB unit costs (after taking credit for applicableexport incentives) work out as follows:

Capacity utilization % 70 80 90 100FOB Unit Costs 97 92 87 82

The company has received three foreign offers from different sources as under:

Source A 5,000 units at Rs. 55 per unit FOBSource B 10,000 units at. Rs. 52 per unit FOBSource C 10,000 units at Rs. 51 per unit FOB

Advise the company as to whether any or all the export orders should be accepted or not.

SolutionX Ltd.

Statement showing differential cost at different capacity utilization Levels

Installed capacity 1,00,000 units.

Capacity production at FOB unit Total Differential Per unitUtilization different levels cost costs costs differential

Fixed expensesContribution


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Decision Making 28

Of capacity costsUtilization

Percent units Rs. Rs. Rs. Rs.70 70,000 97 67,90,000 --- ---80 80,000 92 73,60,000 5,70,000 5790 90,000 87 78,30,000 4,70,00 47100 1,00,000 82 82,00,000 3,70,000 37

Statement showing Gain or Loss on Accepting the Various Export ordersExport Export Capacity Differential cost FOB Sales Gain/Order order utilization per total price revenue (Loss)(Source) (unit) per cent unit per from the

unit exportRs. Rs. Rs. Rs. Rs.

A 5,000 75% 5,000 units 2,85,000 55 2,75,000 (10,000)@ 57

B 10,000 85% 5,000 units

@ 57 5,20,000 52 5,20,000 Nil5,000 units@ 47

C 10,000 95% 5,000 units@ 47 4,20,000 51 5,10,000 90,000

5,000 units@ 37

Total 25,000 95% 12,25,000 13,05,000 80,000

It is obvious from the above statement that the company will gain only when all the three exportorders are accepted. If the company accepts exports only for one or two of the three sources, itwill loose. Therefore, the company should accept all the three exports orders.

_______

Expand or contract decision:

Whenever a decision is to be taken as to whether the capacity is to be expanded or not,consideration should be given to the following points:

a) Additional fixed expenses to be incurredb) Possible decrease in selling price due to increase in productionc) Whether the demand is sufficient to absorb the increased production.

Based on these considerations, the cost schedule will be worked out. While deciding about the

contraction of business, the saving in fixed expenses and the marginal contribution lost will haveto be taken into account. If a branch office is to be closed down and if the branch is given amarginal contribution sufficient to cover fixed expenses the contraction may lead to a loss under:

Problem 20Branch B: Sales Rs. 20,000

P/V ratio 20%Marginal contribution Rs. 4,000Fixed expenses of the branch Rs. 3,000


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Decision Making 29

The branch is giving an extra contribution of Rs. 1,000. if it is closed, the fixed expenses savingis Rs. 3,000 whereas the contribution lost is Rs. 4,000. Hence it is not advisable to contract thebusiness by closing down the branch.

Problem 21K Ltd. manufactures and sells a range of sports goods. Management is considering aproposal for an advertising campaign, which would cost the company Rs. 3,00,000. Themarketing department has put forward the following two alternative sales budgets for thefollowing year:

Products (000 units)A B C D

Budget 1 Without Advertising 216 336 312 180Budget 2 without Advertising 240 373 342 198

Selling prices and variable production costs are budgeted as follows:

Products (Rs. Per units)A B C DSelling prices 11.94 14.34 27.54 23.94Variable production costs:Direct material 5.04 6.60 15.24 12.48Direct labour 2.04 2.04 3.36 3.18Variable overheads 0.72 0.72 1.20 1.08

Other data:(1) The variable overheads are absorbed on a machine hour basis at a rate of Rs. 1.20 per

machine hour.(2) Fixed overheads total Rs. 30,84,000 p.a.

(3) Production capacity during the budget period 8,15,000 machine hours.(4) Products A and C could be bought in at Rs. 10.68 per unit and Rs. 24 per unit respectively.

Required:(i) Determine whether investment in the advertising campaign would be worthwhile and how

production facilities would be best utilized.(ii) Explain the assumptions and reasoning behind your advice.

Solution Statement of products ranking and machine hours required under

Budget 1 and Budget 2_____ Production

A B C D TotalSelling price per unit (Rs.) 11.94 14.34 27.54 23.94Less: Variable cost p.u. (Rs.) _7.80 _9.36 _19.80 _16.74Contribution p.u. (Rs.) 4.14 4.98 7.74 7.20Time in machine (Hrs.) 0.6 0.6 1 0.9

20.1

72.0.Rs

20.1

72.0.Rs

20.1

20.1.Rs

20.1

08.1.Rs

Contribution per machine hour (Rs.) 6.9 8.3 7.79 8Ranking IV I III IIBudget 1 (Mc. Hrs.) 1,29,600 2,01,600 3,12,000 1,62,000 8,05,200Budget 2 (Mc. Hrs.) 1,44,000 2,23,200 3,42,000 1,78,200 8,87,400

(With Advt.)

Available budget hors viz. 8,15,000 hours are sufficient for budget 1. However there is ashortfall of 72,000 hours (8,87,400 8,15,000) to meet Budget 2, targets. These additional


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Decision Making 30

machine hours requirement may be met by way of purchasing either additional units of product Aor C, so that the extra cost of buying machine hours in minimum.

Products A CAdditional buying in cost p.u. (Rs.) 2.88 4.20

(Rs. 10.68-Rs. 7.80) (Rs. 24-Rs. 19.80)Additional buying cost p.u. per machine 4.80 4.20Hours (Rs. 2.88/0.6 hrs.) (Rs. 4.20/ 1hour)

Since additional buying cost per machine hour is minimum in the case of product C, thereforeit is advisable to purchase 72,400 units of product C and thus meet fully the gap in themachine hours requirement i.e. 72,400. The extra cost of buying 72,400 machine hours

would come to Rs. 3,04,080 (72,400 hrsRs. 4.20)

(i) Evaluation of investment in advertisement campaignProducts

A B C D Total

Additional sales volume(000 units): (A) 24 36 30 18units contribution (Rs. 000) : (B) 4.14 4.98 7.74 7.20Additional contribution

(Rs. 000) : (BA) 99.36 179.28 232.20 129.60 640.44

Less: Extra machine buying cost(Rs.000) --- --- --- --- 304.08Less: cost of Advertisement(Rs. 000) --- --- --- --- _300.00Additional profit --- --- --- --- __36.36

The generation of additional profit clearly shows that the investment in advertisement campaign

is worthwhile.Statement of production facilities utilization

Products Machine hours utilized.A 1,44,000B 2,23,200C 2,69,600D __1,78,200Total __8,15,000

(ii) Assumptions:1. Fixed costs (other than advertising) will remain unchanged.2. Variable cost has linear relationship with the volume of production.3. Prices and efficiency will remain unchanged at all levels of output.4. Sales estimates and sound.

Reasoning:The reasoning behind the above advice is based on the fact that the additional revenueexceeds the additional relevant costs and the costs are minimized by buying in product C.

______________

Problem 22

Nice and warm Ltd., manufactures and markets hot plates. During the first five years ofoperation, the company had experienced a gradual increase in sales volume, and the currentannual growth in sales of 5% is expected to continue into the foreseeable future. The plant isnow producing at its full capacity of one lakh hot plates.


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Decision Making 31

At the monthly management advisory committee meeting, amongst other things, the plan ofaction for next year was discussed.

Managing director proposed two alternatives. First, operations could be continued at full capacityand with the existing facilities an output of one lakh hot plates at a selling price of Rs. 100 perunit could be maintained. Secondly, production and sales could be increased by 5% to takeadvantage of the rate of expansion in demand for the product. But this could increase cost, as toachieve the output, the company will have to resort to weekend and overtime workings.However, a policy of steady growth was preferable to maintaining status quo.

In view of the companys competitors having a substantial share of the market, the works directorwas of the view that it was not enough for the company to maintain merely the present share ofthe total market. A larger share of the total market should be obtained. For that, the companyshould increase the production by 10% through a modest expansion of plant capacity. In orderto sell the output of 1,10,000 units, the selling price could be reduced to Rs. 95 per unit.

Thinking on the same lines, the marketing Director put forth a more radical proposal. The

strategy should be to seize the competitive leadership in the market with regard to both price andvolume. With this end in view, he suggested that the company should straight away embark onan expensive modernization programme which will initially increase volume by 20%. The entireoutput of 1,20,000 hot plates could be easily sold at a price of Rs. 90 per unit.

At this juncture managing Director expressed concern about the probable behaviour of thecompanys competitors. They right also expand in order to produce more and sell at lowestprices suppose this happened, he wanted also the financial effects of the proposals of the worksDirector and the marketing director, if in those proposals, the increase in sales were to be onlyhalf of the predicted.

As the cost accountant of the company you are required to critically evaluate the six alternatives,

along with your recommendations and circulate the same to the Directors.

In this connection you have gathered the following details.

(1) If next years production was maintained at the current years level variable costs wouldremain unchanged at Rs. 30 lakhs.

(2) The weekend and overtime working would increase with the variable and fixed costs.Variable cost would rise to Rs. 55 per unit while fixed costs would increase to Rs.30,25,000.

(3) In the proposal of the Works Director, the ratio of variable costs to sales would continue to

be 50% and fixed costs would rise to Rs. 32,25,000.

(4) In the proposal of the marketing Director, as a result of increased production efficiency andsome savings from purchase of materials, it is estimated that the ratio of variable cost tosales would decrease to 48% and the fixed costs would increase by Rs. 5,16,000.

Your Solution should contain:(a) A tabular statement of comparative figures pertaining to Total Turnover, total contribution,

percentage of profit to sales and Break-even units as regards to each of the six proposals.

(b) Comment of the relative risks involved.

(c) Consideration of the short-term and long term implications of the Managing Directorsproposals.


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(d) Comments on the price elasticity of demand for the companys product and yoursuggestions on the pricing policy and cost structure.

(e) Comments on financial implications of the expansion schemes.

Solution(a) Tabular Statement of comparative figures pertaining to total turnover, total contribution,

percentage of profit to sales and break-even units etc., as regards to each of the six proposals.

ProposalsManaging Managing Works Works Marketing Marketing

Directors Directors Directors Directors Directors Directors1st proposal

1st proposals 2nd proposal2nd Proposal

( of expected ( of expected

Increase) increase)(1) (2) (3) (4) (5) (6)units sold 1,00,000 1,05,000 1,10,000 1,05,000 1,20,000 1,10,000Unit sellingPrice (Rs.) 100 100 95 95 90 90Total turnover(Rs. In lakhs) 100.00 105.00 104.50 99.75 108.000 99.00Unit contribution(Rs.) 50 45 47.50 47.50 46.80 46.80Total contribution(Rs. In lakhs) 50 47.25 52.25 49.875 56.16 51.48Fixed cost

(Rs. In lakhs) 30 30.25 32.25 32.25 35.16 35.16profit (Rs. In lakhs) 20 17.00 20.00 17.625 21 16.32% of profit to sales 20% 16.19% 19.14% 17.67% 19.44% 16.48%Break even units 60,000 67,222 67,895 67,895 75,128 75,128Margin of safetyIn units 40,000 37,778 42,105 37,105 44,872 34,872

(b) At the present full capacity level, it is enough to sell 60,000 units to break even. Other proposalsraise the break-even point further. In an uncertain market, if in the proposals of works Directorand the marketing Director, only half the increase is achieved, the margin of safety will be lowerthan the present 40,000 units. Profit as a percentage of sales is also lower than existing in all the

proposals. All this is a disquieting feature as the risk involved is greater in all the otherproposals.

(c) The company had already reached its full capacity. As a short-term measure, the view, neitherof the proposals can be considered to be satisfactory. Both the proposals of the managingDirector do not provide a lasting solution. Though the second proposal maintains the marketshare, it results in less profit, both in quantum and percentage. As the capacity has already beenreached there is an urgent necessity for the Managing Director to address himself to long rangeobjectives and plans keeping in view the expansion in demand for the companys product.

(d) it seems that both the Works Director and the Marketing Director have very elementary notionson price. They think that if the volume increases in order to sell the increased volume, price hasto be lowered. No serious study seems to have been made on the price elasticity of demand forthe companys product. On the other hand, we have been told that there is a steady 5% annualgrowth in demand, which means that the prices need not be reduced, only more market sharehas to be obtained. For incremental production, differential pricing in certain special markets has


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Decision Making 33

to be resorted to; if this is not possible, the increased production can be sold under a differentband name with a different price (A static cost structure, more or less, has been assumed). Tobeat competition, a better product has to be put in the market and cost reduction offered throughvalue analysis, etc.

(e) The expansion scheme envisaged have to be properly tested for profitability by feasibility studyreports, etc. Source of financing the expansion has to be determined. The financial implicationsof share issue or borrowed funds have to be gone through. Long range objectives have to bedefined and plans drawn accordingly to achieve them.

______________

Product Mix decision:

Many times the management has to take a decision whether to produce one product or anotherinstead. Generally decision is made on the basis of contribution of each product. Other thingsbeing the same the product which yields the highest contribution is best one to produce. But, ifthere is shortage or limited supply of certain other resources which may act as a key factor like

for example, the machine hours, then the contribution is linked with such a key factor for taking adecision. For example, in an undertaking the availability of machine capacity is limited and themachine hours required for one unit of the two products are different. In such cases thecontribution is to be linked with the machine hour and the product which yield the highestcontribution per machine hour is to be preferred for taking decision.

Problem 23A company manufactures two products EXE and WYE, which pass through two of itsdepartments exclusively used for them. A market research study conducted by the companyreveals that the company can sale either 38,500 units of EXE or 31,500 units of WYE in a year.The manufacturing cost and selling price details are as under:

EXE WYESelling price per unit 375 540Costs:Department 1:Direct materials 58 100Direct labour 5 hours 50 7.5 hours 75Department 2:Direct materials 21 26Direct labour 7.5 hours 90 10 hours 120

Overheads: Department 1 Department 2Variable overhead rate per direct labour Rs.2.40 Rs.3.60

HourFixed overheads Rs.5, 00,000 Rs.10, 00,000Budgeted direct labour hours 1,75,000 2,80,000

Since the quantity which can be sold exceeded the production capacity, the company has beenconsidering the use of sub-contracting production facilities. Accordingly, when tenders werefloated, two contractors responded as under:

Contractor DS offers to produce upto a maximum of 17,500 units of EXE or 14,000 units of WYEin a year for the type of work done by department 1 of thee company. The price charged by DS isRs.138 per unit of EXE and Rs.212 per unit of WYE. These prices included the cost of directmaterials used in department 1 of the company.

Contractor DW can produce upto a maximum of 11,200 units of and 7,00 units of Wye in a yearfor the type of work done by department 2 of the company. The price charged by DW is Rs.150


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Decision Making 34

per unit of EXE and Rs. 192 per unit of WYE. These prices included the cost of direct materialsused in department 2 of the company.Required:

(1) If the company does not wish to use the sub-contracting facility, which of the two productand in what quantity should be produced and sold by the company by using its ownmanufacturing capacity to earn maximum profit? Calculate the resultant maximum profit.

(2) If the company wishes to produce either 38,500 units of EXE or 31,500 units of WYE by using

sub-contracting facility, state which of the two products should be produced to maximise theprofits. Calculate the resultant maximum profit.

Solution(i) Statement showing the quantity of two products to produced and sold to earn maximum

profit by using own manufacturing capacity

Product .Details EXE WYE

Department 1Number of units produced 35,000 23,333In the department 1 (1,75,000 hrs./5 hrs.) (1,75,000hrs./7.5 hrs.)

Department 2Number of units produced in 37,333 28,000The department 2 (2,80,000 hrs./7.5 hrs.) (2,80,000 hrs. /10 hrs.)Maximum number of units 35,000 23,333Which can be produced &

sold by using the availablehours in the twodepartments.Maximum profit (Rs) 25,95,000 23,49,945(Refer to working note 1) (35,000 units Rs. 117 (23,333 units* Rs. 165

-Rs. 15,00,000) -Rs. 15,00,000)

Decision : The resultant profit earned on the production and sale of 35,000 units of EXE ismaximum , therefore EXE should be produced internally

(ii) Statement of selecting a product yielding maximum profit if the company wishes to produce

either 38,5000 units of EXE or 31,500 units of WYE by using sub-contracting facility)

,------------------------------------------------------------------------------------------------------------------------------Details Either Product

EXE WYE_______Own internal production ( units)

35,000 23,333Sub-contracting the facility required in Department 1 2,333 4,667

(in units)Sub-contracting the facility required in Department 1 1,167 3,500And 2 (units)

Computation of profit :Contribution per unit on internally produced units 117 165(Rs.)


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Decision Making 35

(Refer to working notes 1)Contribution per units when sub-contracting facilities 99 146

OfDepartment 1 were utilised(Rs.)(Refer to working note 2)Contribution per unit, when sub-contracting facilities 87 136Of both the department were utilise (Rs.)(Refer to working note 3)Total contribution (Rs.) 44,27,496 50,07,327(Refer to working note 4)Less: Fixed overheads 15,00,000 15,00.000Profit 29,27,496 35,07,328Decision: The figure profit is maximum for product WYE. Therefore, 31,5000 units of WYE should be

produced to yield a sum of Rs.35,07,328 as profit.

Working notes:1. Contribution per unit on internal production:

ProductEXE WYE-------------------------------------------------------

. Rs. Rs.Selling price units:(A) 375 540Department-1Direct materials 58 100Direct labour 50 75Variable overheads 12 18

(5hrs. X Rs.2.40) (7.5hrs. X Rs.2.40)Manufacturing cost in department 1(B) 120 193

Department-2Direct materials 21 26Direct labour 90 120Variable overheads 27 36

(7.5hrs.X Rs.3.60) (10 hrs X Rs. 3.60)Manufacturing cost in department 2: 138 182Total variable cost of manufacturing per 258 375Unit: (D)= }Contribution per unit :{(A) (D)} 117 165

2. Contribution per unit: (When the facilities of department 1, were sub-contracted but that ofdepartment 2 were utilised internally)

Rs. Rs.Manufacturing cost of sub-contracting of 138 212Department 1Manufacturing cost of internal department 2 138 182Total variable cost of manufacturing per unit 276 394Contribution per unit 99 146

(Rs.375- Rs.276) (Rs.540-Rs.394)

3. Contribution per unit: (When sub-contracting facilities of both the departments were utilized)Rs. Rs.

Manufacturing cost of sub-contracting 138 212department 2Manufacturing cost of sub-contracting 150 192department 2Total variable cost of manufacturing per 288 404Unit


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Decision Making 36

Contribution per unit 87 136(Rs.375 - Rs.288) (Rs.540 - Rs.404)

4. Total contribution :Rs. Rs.

Total contribution on internally 40,95,000 38,49,945produced units (35,000 units x Rs.117) (23,333 units x Rs.165)Total contribution when 2,30967 6,81,382department 1 services were sub- (2,333 units x Rs.99) (4,667 units x Rs.146)contracted ------------------------ ---------------------

44,27,496 50,07,327

Problem 24X Ltd. has two factories, one at Lucknow and another at Pune producing 7,200tonnes and10,800 tonnes of a product against the maximum production capacity of 9,000 and 11,880tonnes respectively at Lucknow and Pune.

10% of the raw material introduced is lost in the production process. The maximum quantity ofraw material, available locally are 6,000 and 13,000 tonnes at Rs. 720 and Rs. 729 per tonne atLucknow and Pune respectively. For the additional needs a supplier of Bhopal is ready to supplyraw material at our factory site at Rs. 792 per tonne.

Other variable costs of production process are Rs. 22.32 lakhs and Rs. 32.94 lakhs and fixedcosts are Rs. 18 lakhs and Rs. 24.84 lakhs respectively for Lucknow and Pune factory.

The output is sold at a selling price of Rs.1,450 and Rs. 1,460 per tonne by Lucknow and Punefactory respectively.

You are required to compute the cost per tonne and net profit earned in respect of each factory.Can you suggest any other alternative production plan for both the factories without any changein present total output of 18,000 tonnes whereby the company may earn optimum profit.

SolutionStatement of cost per tonne and net profit earned in respect of each factory

Lucknow PunePresent production tonnes : (A) 7,200 10,800

Rs. Rs.Cost of raw material (Rs. In lakhs) 59.04 87.48(Ref. To working note 1)

Other variable costs (Rs. In lakhs) 22.32 32.94Fixed costs (Rs. In lakhs) 18.00 24.84Total cost (Rs. In lakhs) (B) 99.36 145.26Cost per tonne (Rs.) : (C) = [(B)/(A)] 1,380 1,345Selling price (Rs.) per tonne : (D) 1,450 1,460Net profit per tonne (Rs.) [(D)-(C)] 70 115Total net profit (Rs. In lakhs) 5.04 12.42

(707,200 tonnes) (11510,800 tonnes)

Total profit of the company = Rs. 17.46 lakhs(Rs. 5.04 + Rs. 12.42)

Alternative production plan to earn optimum profitLucknow Pune


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Decision Making 37

Maximum production capacity (tonnes) 9,000 11,880Present production (tonnes) 7,200 10,800

Rs. Rs.Cost per tonne of output:Cost per tonne of output manufactured from locally 800 810Purchased raw material : (A)(Refer to working note 2)Cost per tonne of output manufactured from material 880 880Purchased from Bhopal : (B)(Refer to working note 3)Other variable cost (Rs.) : (C) 310 305

tonnes

lakhsRs

200,7

32.22.

tonnes

lakhsRs

800,10

94.32.

Selling price per tonne (Rs.) : (D) 1,450 1,460Contribution per tonne of output: [{D-(A+C)}] 340 345(Locally purchased raw material)Contribution per tonne of output 260 275

[(D -(B+C)](When material was purchased from Bhopal)

The propriety to produce 18,000 tonne output is as below as apparent from the above data:PriorityPune factory (Local purchase of raw materials) 1st

Lucknow factory (Local purchase of raw material) 2nd

Pune factory (Raw material purchased from Bhopal) 3rd

Lucknow factory (raw material purchased from Bhopal) 4th

Suggested alternative production planOutput (in tonnes)

Production Raw material Lucknow Pune TotalPriority input (in tonnes)1. 11,700 tonnes 13,000 --- 11,700

11,7002. 5,400 tonnes 6,000 5,400 ---

5,4003. (11,880 11,700) = 180 tonnes 200 --- 180

1804. 720 tonnes balancing figure

(18,000 17,280 tonnes) __800 720 ---720

20,000 6,12011,880 18,000

Working notes:Lucknow Pune

1.Present production output (tonnes) 7,200 10,800Total raw material required for present production (tonnes) 8,000 12,000

90

100200,7 x

90

100800,10 x

Raw Material procured locally (tonnes) 6,000 12,000Raw material procured from Bhopal (tonnes) 2,000 ---Cost of raw material purchased locally and fromBhopal (Rs. In lakhs) 59.04 87.48

(7206,000 (12,000729)

+ 7922,000)


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Decision Making 38

2.Cost per tonne of output manufactured from locallyPurchased raw material (Rs.) 800 810

90

100720x

90

100729x

3.Cost per tonne of output manufactured from material

Purchased from Bhopal (in Rs.) 880 880

90

100729. xRs

Problem 25A company manufactures two products, A and B using imported raw materials. The selling priceof these products are: A Rs. 144, B Rs. 216. The standard cost data are as under:Product Product

A BRs. Rs.

Raw Materials P 15 20Q 5 20

Direct Wages @ Rs. 4/- per hourDepartment 1. 24 36

2. 12 243. 36 4. 48

Variable Overheads 16 14Fixed Overheads per annum Rs. 2,50,000

The Company operates a 8-hour shift for 300 days in a year and the number of workers engagedin each department is given belowDepartment 1 2 3 4

No. of workers 45 24 27 36Required :-(i) How many units of each product should be manufactured and what is the resultant maximum

profit if the number of employees cannot be increased or transferred from one departmentto another.

(i) If only one product is to be manufactured by the company.(a) Which of the products should be manufactured to yield optimum profit and(b) What is the amount of such profit if the availability o

Busines Management

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