The Vernom Corporation, which produces and sells to wholesalers a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter
lotions and creams to prevent dry and chapped skin. After considerable research, a winter products line has been developed. However, because of the conservative nature of the company management, Vernom's president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated. The product selected (called "Chap-off") is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of available capacity, no additional fixed charges will be incurred to produce the product. However, a $100,000 fixed charge will be absorbed by the product to allocate a fair share of the company's present fixed costs to the new product. Using the estimated sales and production of 100,000 boxes of Chap-off as the standard volume, the accounting department has developed the following costs:
|
Direct labor
|
$2.00 per box
|
|
Direct materials
|
3.00 per box
|
|
Total overhead
|
1.50 per box
|
|
Total
|
$6.50 per box
|
Vernom has approached a cosmetics manufacturer to discuss the possibility of purchasing the tubes for Chap-off. The purchase price of the empty tubes from the cosmetics manufacturer would be $0.90 per 24 tubes. If the Vernom Corporation accepts the purchase proposal, it isestimated that direct labor and variable overhead costs would be reduced by 10 percent and direct material costs would be reduced by 20 percent.
1. Should the Vernom Corporation make or buy the tubes? Show calculations to support your answer.
2. What would be the minimum purchase price acceptable to the Vernom Corporation for the tubes? Support your answer with an appropriate explanation.
3. Instead of sales of 100,000boxes, revised estimates show sales volume at 125,000boxes. At this new volume, additional equipment, at an annual rental of $lO,OOO, must be acquired to manufacture the tubes. However, this incremental cost would be the only additional fixed cost required even if sales increased to 300,000 boxes. (The 300,000 level is the goal for the third year of production.) Under these circumstances, should the Vernom Corporation make or buy the tubes? Show calculations to support your answer.
4. The company has the option of making and buying at the same time. What would be your answer to question 3 if this alternative was considered? Show calculations to support your answer.
5. What nonquantifiable factors should the Vernom Corporation consider in determining whether they should make or buy the lipstick tubes?