Companies must decide which products to emphasize if certain constraints prevent unlimited production or sales.
Assume that A. B. Fast produces oil filters and windshield wipers.
The company has 2,000 machine hours available to produce these products.
Product Mix A. B. Fast can produce 5 oil filters in one hour or 8 windshield wipers. Product Oil Windshield Per Unit Filters Wipers Sales price $3.22 $13.50 Variable expenses 1.50 12.00 Contribution margin $1.72 $ 1.50 Contribution margin ratio 53% 11%
Product Mix Which product should A. B. Fast emphasize? Oil filters: $1.72 contribution margin per unit × 5 units per hour = $8.60 per machine hour Windshield wipers: $1.50 contribution margin per unit × 8 units per hour = $12.00 per machine hour
A. B. Fast is considering the production of a part it needs, or using a model produced by C. D. Enterprise.
C. D. Enterprise offers to sell the part for $0.37.
Should A. B. Fast manufacture the part or buy it?
Outsourcing (Make or Buy) A. B. Fast has the following costs for 250,000 units of Part no. 4: Part no. 4 costs: Total Direct materials $ 40,000 Direct labor 20,000 Variable overhead 15,000 Fixed overhead 50,000 Total $125,000 $125,000 ÷ 250,000 units = $0.50/unit
Assume that by purchasing the part, A. B. Fast can avoid all variable manufacturing costs and reduce fixed costs by $15,000 (fixed costs will decrease to $35,000).
A. B. Fast should continue to manufacture the part.
Outsourcing (Make or Buy) Purchase cost (250,000 × $0.37) $ 92,500 Fixed costs that will continue 35,000 Total $127,500 The unit cost is then $0.51 ($127,500 ÷ 250,000). $127,500 – $125,000 = $2,500, which is the difference in favor of manufacturing the part.
Assume that if A. B. Fast buys the part from C. D. Enterprise, it can use the facilities previously used to manufacture Part no. 4 to produce gasoline filters.
The expected annual profit contribution of the gasoline filters is $17,000.
What should A. B. Fast do?
Best Use of Facilities Expected cost of obtaining 250,000 parts: Make part $125,000 Buy part and leave facilities idle $127,500 Buy part and use facilities for gas filters $110,500* *Cost of buying part: $127,500 less $17,000 contribution from gasoline filters.
A. B. Fast should process further, because the $75,000 extra revenue ($880,000 – $805,000) outweighs the $25,000 cost of extra processing.
Extra sales revenue is $0.30 per filter.
Extra cost of additional processing is $0.10 per filter.
Sell As-Is Or Process Further Cost to produce 250,000 parts: $500,000 Sell these parts for $3.22 each: $805,000 Cost to process original parts further: $ 25,000 Sell these parts for $3.52 each: $880,000 Sales increase ($880,000 – $805,000) $ 75,000 Less processing cost 25,000 Net gain by processing further $ 50,000
A. B. Fast is considering an investment of $450,000.
This proposed investment will yield periodic net cash inflows of $225,000, $230,000, and $210,000 over its life.
A. B. Fast expects a return of 16%.
Should the investment be made?
Net Present Value Example Periods Amount PV Factor Present Value 0 ($450,000) 1.000 ($450,000) 1 225,000 0.862 193,950 2 230,000 0.743 170,890 3 210,000 0.641 134,610 Total PV of net cash inflows $499,450 Net present value of project $ 49,450