Assignment Chapter 4

4.29 Keep or Drop, Multiple Product Breakeven, Qualitative Factors Horton and Associates
produces two products named Big Winner and Loser. Last month 1,000 units of Loser and 4,000
units of Big Winner were produced and sold. Average prices and costs for the two products for last
month follow:

  Lose Big Winner

r
Selling price $95 $225
Direct materials 40 95
Direct labour 5 25
Variable overhead 5 15
Product line fixed costs 10 40
Corporate fixed costs 25 25
Average margin per unit $10 $ 25

The production lines for both products are highly automated, so large changes in production cause
very little change in total direct labour costs. Workers who are classified as direct labour monitor the
production line and are permanent employees who regularly work 40 hours per week.

All costs other than corporate fixed costs listed under each product line could be avoided if the
product line were dropped. Corporate fixed costs totalled $125,000, and the total sales amounted to
5,000 units, producing the average cost per unit of $25. About $10,000 of the corporate fixed costs
could be avoided if Loser were dropped, and about $15,000 of the corporate fixed costs could be
avoided if Big Winner were dropped. The remaining $100,000 could be avoided only by going out of
business entirely.

REQUIRED:

 A. What is the overall corporate breakeven in total sales revenue, assuming that the sales mix
is the same as last month's?

  B. What is the breakeven sales volume (in units produced and sold) for Loser? (In other
words, what is the sales volume at which Horton should be financially indifferent between
dropping and retaining Loser?)

  C. List at least two qualitative factors that would affect the decision to keep or drop Loser.
4.32 Make or Buy, Qualitative Factors The Vernom Corporation produces and sells
Q2, Q5 to wholesalers a highly successful line of summer lotion and insect repellents.
Vernom has decided to diversify 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 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 is a lip balm to be sold in a lipstick-type tube. The product
will be sold to wholesalers in boxes of 24 tubes for $8.00 per box. Because of
available capacity, no additional fixed charges will be incurred to produce the
product. However, a $200,000 fixed charge will be assigned to allocate a fair
share of the company's fixed costs to the new product. The remaining overhead
costs are variable.

Using estimated sales and production of 100,000 boxes of lip balm as the
standard volume, the accounting department has developed the following costs
per box of 24 tubes:

Direct labour $4.00

Direct 6.00
materials
Total overhead 3.00

Total $13.00

Vernom approached a cosmetics manufacturer to discuss the possibility of

purchasing the tubes for the new product. The purchase price of the empty tubes
from the cosmetics manufacturer would be $1.80 per 24 tubes. If Vernom accepts
the purchase proposal, it is estimated that direct labour and variable overhead
costs would be reduced by 10%, and direct materials costs would be reduced by
20%.

REQUIRED:

 A. Should the Vernom Corporation make or buy the tubes? Show

calculations to support your answer.

  B. What would be the maximum purchase price acceptable to Vernom for

the tubes? Explain.

  C. Instead of sales of 100,000 boxes, revised estimates show sales volume

at 125,000 boxes. At this new volume, additional equipment at an
annual rental of $20,000 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 Vernom make or buy the tubes? Show calculations to support
your answer.

 D. The company has the option of making and buying at the same time.
What is your answer to Part C if this alternative is considered? Show
calculations to support your answer.

  E. What qualitative factors should Vernom managers consider in

determining whether they should make or buy the lipstick tubes?