Decision Making 1

2( b-e ). AREAS OF DECISION MAKING

Learning objective
In this chapter we will check different types decision making problems as faced by top
management 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 follows
1. product sales pricing & mix
2. limiting factors
3. multiple scare resource problem ( Ref chapter 10a)
4. make or buy
5. 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 more
than 1 product).
(1) Differential cost & incremental Revenue analysis where the production & sales will continue till
Marginal Revenue > Marginal costs.
(3) Indifference cost approach
(4) Relevant cost approach i.e. considered only those cost & revenues which are related to the
purpose 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 is
accepted.
In case of problem where minimum sale price is to be quoted then total relevant cost = Total
minimum sales price.
Decision Making 2
Limiting Factor Problems
When many products are produced from a single resource & total resources requirement
of the product is greater then resource available, then it known as limiting factor of
production.
Objective of the management maximization of contribution or contribution-Discretionary
Fixed 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 production
equipment for all products 1
st
allot the limiting resource to fulfill the minimum production
condition & then allot it on the basis of rank.
Step-5:
Prepare the profit statement & determine the best product mix.
Problem 1
Universe 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 Manger
are as under:
Product-X______________ Product-Y
Selling price Sales potential selling price Sales potential
Per unit (Rs.) (in units) per unit (Rs.) (in units)
110 5,000 78 30,000
108 7,500 77 32,000
107 8,000 75 35,000
103 8,400 72 40,000
96 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 45,000
Total costs per month (Rs. In lakhs) 5 6.6 18 25.5
Labour 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.
Decision Making 3
Solution
Working 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 contribution
Product-X Product-Y
Selling contribution units Total selling contribution units total
Price p.u. per unit contribution price p.u (SP-VC) contribution
Rs. Rs. (Rs. Lakhs) Rs. Rs. (Rs. Lakhs)
110 70 5,000 3.5 78 28 30,000 8.4
108 68 7,500 5.1 77 27 32,000 8.64
107 67 8,000 5.36 75 25 35,000 8.75
103 63 8,400 5.292 72 22 40,000 8.80
96 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) at
selling 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 Y
Sellingincremental incremental contribution selling incremental incremental contribution
Pricecontribution labour hrs per hour price contribution labour hrs per hour
Per unit per unit
Rs. Rs. Lakhs units 4 hrs Rs. Rs. Rs. Lakhs (Units 2 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 14.00
108 1.6 10,000 16.00 77 0.24 4,000 6.00
107 0.26 2,000 13.00 75 0.11 6,000 1.83
103 (-0.068) 1,600 (-4.25) 72 0.05 10,000 0.50
96 (-0.252) 2,400 (-10.50) 69 (-0.25) 10,000 (-2.50)
4. Ranking of products X and Y based on the incremental
Contribution per hour as per working note 3
Sl No. selling price Incremental Product Ranking
Contribution per hour
Rs. Rs.
1. 110 17.50 X I
2. 108 16.00 X II
3. 78 14.00 Y III
4. 107 13.00 X IV
5. 77 6.00 Y V
6. 75 1.83 Y VI
7. 72 0.50 Y VII
(a) Statement of selling price and units to earn maximum profit
(No restriction on the availability of labour hours)
Change in total cost of a product
Change in the output of the product
Decision Making 4
Products X Y Total
Output and sales (in units) of
Optimum contribution per month (1) 8,000 40,000
(Refer to working note 2)
Selling price p.u. (Rs.) 107 72
Contribution (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 earn
Maximum profit when only 95,000 labour hours are available
Products selling incremental incremental Labour Total
Price 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 3.50
X 108 16.00 2,500 10,000 1.60
Y 78 14.00 30,000 60,000 8.40
X 107 13.00 500 2,000 0.26
Y 77 6.00 1,500* 3,000* ___0.18
95,000 13.94
Less: Fixed costs __6.00
Profit 7.94
Balancing figure
Problem 2
A Company produces three products from an imported material. The cost structure per unit
of the products are as under:
Products A B C
Rs. Rs. Rs.
Sales value 200 300 250
Direct materials 50 80 60
Direct wages Rs. 6 per hour 60 120 108
Variable 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 the
following 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 restricted
to 10,000 kgs per month, how the profit could be maximized?
Solution
Working Notes:
Value of imported and indigenous material and quantity of imported material consumed P.u..:
Decision Making 5
Products A B C
Value of imported material p.u. (Rs.) 40 64 48
Value of indigenous material p.u. (Rs.) 10 16 12
Quantity of imported material consumed p.u. (Kg.) 4 6.4 4.8
Statement of profitability
Products A B C
Sales value p.u. (Rs.) : (X) 200 300 250
Direct material (Rs.) 50 80 60
Direct wages (Rs.) 60 120 108
(10 hrs (20 hrs. (18 hrs
Rs. 6) Rs. 6) Rs. 6)
Variable overheads (Rs.) __30 __60 __54
Total variable cost (Rs.) : (Y) 140 260 222
Contribution p.u. (Rs.): (X-Y) 60 40 28
P/V ratio:
]
]
]

100 x
S
C
30% 13.33% 11.2%
Contribution per kg. Of imported materials (Rs.)
(Refer to working note) 15 6.25 5.83
Contribution per hour of production (Rs.) 6 2 1.6
(60/10 hrs.) (40/20 hrs)(28/18 hrs)
(i)
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 profit
Products A B C
Maximum sales (units) 1,000 1,000 500
Requirement of imported material p.u. (kg) 4 6.4 4.8
Total requirement of imported material for
Maximum sales (kg.) 4,000 6,400 2,400
Contribution per kg. (Rs.) 15 6.25 5.83
For maximizing profit 10,000 kg. Of imported
Material is to be used for manufacturing those
Products where contribution per kg is maximum.
But 500 units of C must be produced to meet
Specific requirement. Hence the material
Utilized will be (Kg.) 4,000 3,600 2,400
No. of units 1,000 562 500
Maximum profit (Rs.) 60,000 22,480 14,000
Problem 3
On a turnover of Rs. 20 crores in 1997, a large manufacturing company earned a profit of
10% before interest and depreciation, which were fixed. The product mix of the company
was as under:
Products Mix % PV ratio Raw materials
To total sales % as % on sales value
P 10 30 40
Q 30 20 35
R 20 40 50
S 40 10 60
Interest and depreciation amounted to Rs. 150 lakhs and Rs. 77 lakhs respectively due to
fluctuation in prices in the international market, the company anticipates that the cost of raw
materials which are imported will increase by 10% during 1997. The company has been able
to secure a licence for the import of raw materials of a value of Rs. 1,023 lakhs at 1997
Decision Making 6
prices. In order to counteract the increase in costs raw materials the company in
contemplating to revise its product mix. The market survey report recently prepared indicates
that the sales potential of each of the products P, Q and R can be increased up to 30% of
total sales value of 1997. There is no inventory of finished goods or work-in-process in both
the 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%.
Solution
Working notes
(a)
Existing and revised raw material costs
Product Mix % toSales Raw materials Existing cost increased Revised raw
Total sales as % of sale of raw material cost of raw material as
Value material % of sales
After 10% value
Rise
Rs. Lakhs Rs. Lakhs Rs. Lakhs
P 10 200 40 80 88 44
Q 30 600 35 210 21 38.5
R 20 400 50 200 220 55
S 40 800 60 480 528 66
2,000 970 1,067
(b) Revised P/V ratio and ranking of products
Product Existing increase Revised contribution rank
P/V ratio in raw - P/V ratio per Rs. 100 of
% material % raw material
over sales
Value
P 30 4.0 26.0 59.09 II
Q 20 3.5 16.5 42.86 III
R 40 5.0 35.0 63.64 I
S 10 6.0 4.0 6.06 IV
(c) Maximum sales potential
Rs. In lakhs
P 30% Rs. 2,000 =600
Q 30% Rs. 2,000 =600
R 30% Rs. 2,000 =600
S 40% Rs. 2,000 =800
(d) Allocation of raw material whose supply is restricted to Rs. 1,023 lakhs in order of raw material
profitability.
Product Rank Sales Raw materials Raw material Balance raw
Rs. Lakhs per Rs. 100 required material
Lakhs sales
Decision Making 7
Rs. Lakhs Rs. Lakhs Rs. Lakhs
1 2 3 4 5 =(3 4) 6
Balance raw materials 1,023
R I 600 55.0 330 693
P II 600 44.0 264 429
Q III 600 38.5 231 198
S IV 300* 66.0 198* Nil
* Balance to be used for the production/ Sales of product S (198 0.66 = Rs. 300 lakhs)
(e) Total contribution in 1997 (Rs. In lakhs)
Product Sales P/V ratio % Contribution
P 200 30 60
Q 600 20 120
R 400 40 160
S __800 10 __80
_2,000 _420
(f) Computation of fixed costs: Rs. In lakhs
Present turnover 2,000
Profit (10% of Rs. 2,000 lakhs) 200
Less: Interest 150
Depreciation __77
Total 227 __227
Net loss __27
Rs. In lakhs
Total contribution 420
Add: Net loss __27
Fixed expenses _447
(i) Optimal mix and profitability for 1997
Product Optimum sales Revised P/V Contribution
Rs. In lakhs ratio % Rs. In lakhs
P 600 26.0 156
Q 600 16.5 99
R 600 35.0 210
S 300 4.0 __12
2,100 477
Less: Fixed costs _447
Profit __30
(ii) Required percentage increase in overall price (sales value) in 1997:
Break-even sales:
477 .
100 , 2 . 447 .
Rs
xRs Rs
= Rs. 1,967.92 lakhs
Required sale for 10% margin of safety:
Rs. 1967.92
90
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
100 58 . 86 . x Rs
= 4.12%
Acceptance of an offer and submission of a tender:
Decision Making 8
Acceptance of an offer: When a firm having surplus capacity receives an offer from a special or
export market, a decision as to whether to accept or not to accept the offer can be taken after the
analysis of the incremental cost and incremental revenue.
Problem 4
A co. Ltd. manufactures several different styles of jewellery cases. Management estimates
that 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 consider
a special order.
The company has received special order inquires from two companies. The first order is
from JCP Co. Ltd., which would like to market a jewellery case similar to one of A co. Ltd. has
offered A co. Ltd. Rs. 57.50 per jewellery case for 20,000 cases to be shipped by the last
date of the quarter. The cost data for A Co. Ltd. Jewellery case that would be similar to the
specification of JCP special order are as follows:
Rs.
Regular selling price per unit 90
Cost per unit
Raw Materials 25
Direct labour 0.5 hours @ Rs. 60 30
Overhead 0.25 machine hour @ Rs. 40 10
Total costs 65
According to the specifications provided by JCP Co. Ltd. the special order case requires less
expensive 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 be
the 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. 75
per case. These jewellery cases, like the JCP cases, would be marketed under K label and
have to be shipped by the last date of the quarter. However, the K jewellery case is different
from any jewellery case in the A Co. line. The estimated per unit cost of this case are as
follows:
Rs.
Raw materials 32.50
Direct labour 0.5 hour @ Rs. 60 30.00
Overhead 0.5 machine hour @ Rs. 40 20.00
Total costs 82.50
In addition, A Co. ltd. will incur Rs. 15,000 in additional setup costs and will have to purchase
a Rs. 25,000 special device to manufacture these cases, this device will be discarded once
the special order is completed.
The A. Co. Ltd.s manufacturing capabilities are limited to the total hours available. The plant
capacity under normal operations is 90,000 machine hours per year or 7,500 machine hours
per month. The budgeted fixed overhead for the current year amounts to Rs. 21,60,000. All
manufacturing 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 practice
precludes from subcontracting any portion of an order, when special orders are not expected
to generate repeat sales.
Required: Should A Co. Ltd. accept either Special order? Justify your Solution and show the
calculations.
Decision Making 9
Solution
Statement 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 75.00
Less: Cost per unit 56.50 70.50
(Refer to working note 2) ______ _______
Profit per unit __1.00 ___4.50
Total profit 18,000 33,750
(18,000 units Re. 1) (75,00 Rs. 4.50)
Less: Costs of set up and special device __Nil 40,000
Net 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 of
order 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 hours 3 months)
Hours utilized for 80% operating level 18,000
(22,500 hours 80%) _______
Total unutilized hours during the third quarter ___4,500
2. Computation of fixed and variable overhead rate
Fixed overheads p.a. (Rs.) 21,60,000
Normal capacity hours 90,000
Fixed overheads rate per hour (Rs.) 24
(Rs. 21,60,000/90,000 hours)
Manufacturing overhead application rate per hour (Rs.) 40
Therefore, 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 32.50
Direct Labour 30.00 30.00
Variable overheads 4.00 8.00
(0.25 hours Rs. 16)(0.5 hrs Rs. 16)
Total cost per unit 56.50 70.50
__________
Problem 5
Unique Products manufactures and sells in a year 20,000 units of a particular product to
definite customers at a price of Rs. 100 per unit. The concern has a capacity to produce
25,000 units of the product per annum. To produce beyond 25,000 units per annum, the
Decision Making 10
concern will have to install a new equipment at a cost of Rs. 15 lakhs. The equipment will
have a life span of 10 years and will have no residual value. There is an offer form a client to
purchase 10,000 units of the product regularly at a price of Rs. 90 per unit. The order, if
accepted, will have to be over and above the existing level of production of 20,000 units.
The cost structure is as under: Per unit
Rs.
Direct Material 30
Direct Labour 20
Variable overhead 10
Profit 20
During the coming year, it has been estimated that the cost of direct material, as compared to the
current 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 is
accepted, fixed overheads will increase further by Rs. 60,000 due to increased administrative
charges.
You are required to analyze whether the concern should accept the order or instead of that
try to secure order for the balance unused capacity, as available now through some sales
promotion expenses which will be Rs. 50,000 p.a. Ignore financial charges for the new
investment.
Solution
Comparative cost statement of the three proposals (Based on revised cost structure)
Proposal 1 Proposal 2 Proposal 3
Sell 20,000 secure orders for Accept the new
Units 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
(20,000 units (25,000 units (30,000 units
Rs. 33) Rs. 33) Rs. 33)
Direct labour 5,00,000 6,25,000 7,50,000
(20,000 units (25,000 units (30,000 units
Rs. 25) Rs. 25) Rs. 25)
Variable overheads 2,00,000 2,50,000 3,00,000
(20,000 units (25,000 units (30,000 units
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 -- --- 60,000
Add: Sales promotion Expenses -- 50,000 ---
Depreciation (New equipment) -- -- 1,50,000
Total cost : (B) 18,00,000 21,90,000 26,90,000
Profit : (C) = {(A B)} 2,00,000 3,10,000 2,10,000
Decision Making 11
Analysis: An analysis of the profit figures of M/s Unique products under three proposals clearly shows
that it is maximum under proposals 2. Therefore, it is advisable for the concern to produce and
sell 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 80 100
7,000 75 97
8,000 74 95
9,000 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 should
be accepted or not.
Solution
Apparently the unit cost at 9,000 and 10,0000 units capacity is Rs. 72 and Rs.71 respectively
and since the export order is at Rs. 70 per unit, the order is not profitable. But this is a wrong
approach. Let us tabulate the figure again and see the result.

Capacity Unit Total Incremental unit Total sales Incremental
Cost cost cost price value revenue
Rs. 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 79,000
8,000 74 5,92,000 67,000 95 7,60,000 81,000
9,000 72 6,48,000 56,000
10,000 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. 5,92,000
leaving a profit of Rs. 1,68,000. The fact that this level of output leaves a profit means that the
fixed expenses have been recovered already. Hence we have to take only the incremental cost
for 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 incremental
revenue approach is useful. Considering the above example, if the firm operates at 8,000 level of
output and quotations are to be given, any price quotation above the unit incremental cost of Rs.
59 would be profitable.
Problem 7
All Play and Nowork Ltd. are specialists in the manufacture of sports goods. They manufacture
croquet mallets but purchase the wooden balls, iron arches and stakes required to complete a
croquet set.
Mallets consist of a head and handle. Handles use 1.5 board feet per handle at Rs. 40 per board
foot. Spoilage loss is negligible for the manufacture of handles.
Heads frequently split and create considerable scrap. A head requires 0.20 board feet of high
quality lumber costing Rs. 70 per board foot. Spoilage normally works out to 20% of the
completed heads. 4% of the spoiled heads can be salvaged and sold as scrap at Rs. 10 per
spoiled head.
Decision Making 12
In the department machining and assembling the mallets, 12 men work 8 hours per day for 25
days in a month. Each worker can machine and assemble 15 mallets per uninterrupted 50
minutes time frame. In each 8 hours working day, 15 minutes are allowed for coffee break, 8
minutes on an average for training and 9 minutes for supervisory instruction. Besides 10% of
each 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 of
Rs. 6 per hour.
The department is geared to produce 40,000 mallets per month and the monthly expenses of the
department are as under:
Rs.
Finishing and painting of the mallets 50,800
Lubricating oil for cutting machines 300
Depreciation for cutting machine 700
Repairs and maintenance 100
Power to run the machines 200
Plant Managers salary 2,700
Other 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 lot
and advise the management on the selling price to be fixed per mallet in order to ensure a
minimum 20% margin on the selling price.
Solution
All play and Nowork Ltd.
Cost Sheet of one lot of 500 Croquet Mallets
Rs. Rs. Rs.
Direct Materials:
Handles (1.5 feet 500 units Rs. 40) 30,000
Heads (1.20 500 0.20 Rs. 70) 8,400
(Refer to working note 1)
Less: scrap recovery
(4% 100 Rs. 10) ___40 8,360 38,360
Direct labour:

,
`

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|
500
120
6 . . 8
x
xRs hrs
(Refer to working note 2) 200
Prime cost 38,560
Factory & other overheads:
Variable
Finished & 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
(20% margin on selling price means 25% on cost) ______
selling price 102.29
Decision Making 13
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: 1.20 500 = 600, of which spoiled
heads are 100.
2. Total time in a day: 8 60 480 minutes
Less: Idle time 48 minutes
Coffee break 15 minutes
Instructions 9 minutes
Training 8 minutes 80 minutes
Productive time per day: 400 minutes
Therefore, mallets to be produced per man per day:
,
`

.
|
15
50
400
x
= 120 units
3. Finishing and painting overheads are assumed to be variable for the production of 40,000
mallets.
4. All the other expenses are fixed and are to be absorbed by 36,000 mallets of monthly
production. Since mallets are produced at the rate of 120 mallets per man day, so total
monthly production will be: 120 units 12 men 25 days = 36,000 mallets.
_______________
Problem 8
Somesh of Agra presently operates its plant at 80% of the normal capacity to manufacture a
product 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 1,00,000
Semi-variable 40,000 42,500 45,000
Fixed 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 export
price.
Solution
Working 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 16
Less: Indirect costs __10
(Rs. 2,00,000/20,000 units)
Direct cost per unit ___6
Decision Making 14
2. Statement of differential cost for 4,000 units
(20% of 20,000 units)
Present proposed Differential
Production production cost for
20,000 24,000 4,000
units units units
Rs. Rs. Rs.
Direct cost @ Rs. 6/- p.u. 1,20,000 1,44,000 24,000
Indirect cost:
Variable @ Rs. 4/- p.u. 80,000 96,000 16,000
Semi variable 40,000 44,000 4,000
Fixed 80,000 81,000 1,000
Total 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 1/9
th
of cost)
_______
Price to be quoted _50,000
Export price per unit; Rs. 12.50
(Rs. 50,000/4,000 units)
___________
Problem 9
A company can produce and sell at its maximum capacity 20,000 units of a product. The sale of
price is Rs. 100. The present sales 15,000 units. To produce over 20,000 units and up to
another 10,000 units some balancing equipments are to be installed at a cost of Rs. 10 lakhs and
the same will have a life span of 10 years.
The current cost structure is as under:
Direct material 30% of sales value
Direct labour 20% of sales value
Variable overheads Rs. 20 per unit
Profit 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 level
of output on a long-term basis at a unit price of Rs. 90. Apart from the investment of Rs. 10
lakhs, as shown above, the fixed overheads will increase by Rs. 50,000 due to additional
administrative expenses.
The Company is in a dilemma as to whether to accept the order for 10,000 units or to use the
present unused capacity of 5,000 units for which there will be additional selling expenditure of
Rs. 50,000.
Ignore financing charges and give your recommendation.
Solution
Working Note: Rs.
Decision Making 15
Fixed overheads:
Present sales value: (A) 15,00,000
(15,000 units Rs. 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) 10,50,000
Contribution: (C) : (A) (B) 4,50,000
Profit: (D) 2,25,000
(15,000 units 15) ________
Fixed overheads: (C) (D) 2,25,000
(current level)
Add: Additional fixed overheads due to price escalation __50,000
Total fixed overheads 2,75,000
Statement of profitability for various alternatives
Alternatives I II III IV
Rejecting the proposal rejecting the proposals Accepting the Accepting the
For 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 take
Continuing 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 a
Selling expenditure balancing equipment balancing
& Continuing with equipment &
Present level of attaining sale of
Sales maximum available
Capacity by incurring
Additional selling
Expenditure
Sales (Units) 15,000 20,000 25,000 30,000
Rs. Rs. Rs. Rs.
Sales value: (A) 15,00,000 20,00,000 24,00,000 29,00,000
(15,000 Rs. 100) (20,000 Rs. 100) (15,000 Rs. 100 (20,000 Rs. 100
+ 10,000 Rs. 90) + 10,000 Rs. 90) + (10,000 Rs. 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 23,40,000
Fixed costs:
(Ref. To working note) 2,75,000 2,75,000 2,75,000 2,75,000
Additional selling
Expenditure --- 50,000 --- 50,000
Deprecation for
Balancing equipment --- --- 1,00,000 1,00,000
Additional administrative
Expenses ______--- --- 50,000 50,000
Total fixed costs: (C) 2,75,000 3,25,000 4,25,000 4,75,000
Total costs D: [(B)+(C)] 14,45,000 18,85,000 23,75,000 28,15,000
Profit : (A) (D) 55,000 1,15,000 25,000 85,000
Decision Making 16
* Note: For computing the material and labour cost under alternative III & IV the notional sale
price of Rs. 100 is taken for additional 10,000 units.
Recommendations: Alternative II is the best as it gives maximum profit.
_________
Problem 10
R. Ltd. will produce 3,00,000 kgs. Of S and 6,00,000 kgs. Of Y from an input of 9,00,000 kgs. Of
raw 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. 27,00,000
Variable processing costs 18,00,000
Fixed 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 existing
market for Y will not be affected by accepting the offer. But the price of S is likely to be
decreased uniformly on all sales.
Find the minimum reduced average price for S to sustain the increased sales.
Solution
Since S & Y are produced simultaneously from an input of raw material Z, therefore when
additional 60,000 kgs. of Y will be produced then 30,000 kgs. of S will also be produced
simultaneously. 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 material
will 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 4,50,000
Less: Sales revenue from 60,000 kgs. of Y 2,40,000
(60,000 kgs Rs. 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 recover
Rs. 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 part
should 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, and
b) The marginal cost.
Decision Making 17
Problem 11 The total cost of a manufactured component is as under:
Prime cost Rs. 15 Fixed overhead Rs. 4
Variable 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.
Solution
If surplus capacity is available and will remain idle if the component is bought, the out of pocket
expenses will be Rs. 23 per unit. Re. 1 more than the variable (relevant) cost of making
component, which is Rs. 22 (Rs. 15 + Rs. 7). Hence, it is economical to make it. However, if the
firm is utilizing or can utilize the capacity in making some other part which contributes, say Rs. 4
per unit, the effective cost of buying the component will be Rs. 19 (Rs. 23 less Rs. 4 contribution
from other product). In that case, it would be economical to buy the component at Rs. 23 per unit
from outside. The relevant computations for taking decision may be as follows:
Make Per unit cost Buy and use
Buy and leave capacity for
Capacity idle other product
Rs. Rs. Rs.
Cost of making/buying (22) (23) (23)
Contribution from other production __--__ __--__ ___4
Net relevant cost __(22) __(23) __(19)
____________________
Problem 12
Perfect product Ltd. is currently buying a component from local supplier at Rs. 15 each the
supply is tending to be irregular. Two proposals are under consideration:
1. Buy and install a semi automatic machine for manufacturing this component, which would
involve an annual fixed cost of Rs. 9 lakhs and a variable cost of Rs. 6 per manufactured
component.
2. Buy and install an automatic machine for manufacturing this component, incurring an annual
fixed 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 the
semi-automatic machine.
(3) If the annual requirement of the coming year is expected to be 5,00,000 nos. and the
volume is expected to increase rapidly thereafter, would you recommend the automatic or
semi-automatic machine. Justify your recommendation.
Solution
(1) Proposal 1 Proposal 2
semi-automatic automatic
machine machine
Rs. Rs.
Purchase cost per unit for the component now being bought 15 15
Decision Making 18
Less: unit variable cost for won manufacture __6 __5
Unit contribution from own manufacture 9 10
Total annual fixed cost to be recouped 9,00,000 15,00,000
No. 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 justify
own 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 of
over 1,50,000 Nos.
(2) Incremental annual fixed cost if automatic machine is chosen: Rs. 6,00,000
Saving in unit variable cost by choosing the automatic machine Re. 1
Production 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 it
would involve a lower total cost per unit of the component, as indicated below:
semi-automatic automatic
Rs. Rs.
Total variable costs:
5,00,000 units @ Rs. 6 and Rs. 5 respectively 30,00,000 25,00,000
Total fixed costs 9,00,000 15,00,000
Total costs 39,00,000 40,00,000
Total cost per unit 7.80 8.00
However, the annual requirement is expected to increase rapidly beyond 5,00,000 units; as soon
as it is 6,00,000 units the semi-automatic machine will become more expensive as compare to
the automatic machine. Then the need for installing the automatic machine will arise which may
be within a very short period after commissioning the semi-automatic machine. Replacement of
the semi-automatic machine by an automatic machine may then become costly, not only
because of the loss that may arise on the semi-automatic machine but also by possible a higher
price of the automatic machine. The management may therefore, install an automatic machine
immediately.
__________
Problem 13
Agrocaps 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 be
insufficient 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 unit
Component A B C D
Rs. Rs. Rs. Rs.
Variable cost:
Direct Materials 37 27 25 44
Direct Wages 10 8 22 40
Direct expenses 10 20 10 60
Decision Making 19
Fixed overheads __5 __4 _11 _20
Total production cost p.u. _62 _59 _68 164
Requirements 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, each
delivered to the factory:
Component Rs.
A 60
B 59
C 52
D 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 required
Component A B C D
Rs. Rs. Rs. Rs.
Direct expenses per unit 10 20 10 60
No. 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 unit
Component A B C D
Rs. Rs. Rs. Rs.
Marginal (Variable) Costs
Direct material 37 27 25 44
Direct wages 10 8 22 40
Direct expenses 10 20 10 60
Marginal cost per unit: (A) 57 55 57 144
Bought out price: (B) 60 59 52 168
Excess of bought out price over marginal ___ ___ ___ ___
Cost: {(B-A)} 3 4 (5) 24
Press hours per unit __1 ___2 __1 __6
Excess of bought out price per unit of limiting __3 __2 _(5) _4
Factor (i.e. press hour).
The bought-out price for component C is lower by Rs. 5 than the marginal cost of production and
so it should be purchased from outside.
In case the remaining components A, B and D are bought, their ranking in terms of loss per unit
of limiting factors (Press hour) would be D (highest loss per unit), A and B. The capacity
available should, therefore, be deployed for making D first and then A and thereafter B.
Decision Making 20
Components and their quantities to be manufactured in 20,000 hours of press time available
(Singe shift operation)
Hours
Available 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 units 1 hour) 2,000
Balance hours available 1,200
Third, produce B, for the balance hours available (600 units 2hours) 1,200
Balance hours available ___Nil
So, in 20,000 hours of press time available, all the requirements of components D and A and
only 600 units of component B can be manufactured. The balance requirement of component B
i.e. 2,900 (3,500-600) units of component will have to be bought out or manufactured in the
second 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 should
be purchased from outside.
Now it is to be seen whether 2,900 units of B should be produced in the second shift or bought
from 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 55.00
Add: Increase in direct wages per unit __2.00
Variable cost per unit 57.00
Total Variable cost for 2,900 units, (2,900 units Rs. 57) 1,65,300
Additional fixed cost:
Hours required for 2,900 units of B (2,900 units 2 hours) = 5,800 hrs.
Extra fixed cost for 5,800 hours at Rs. 500 for every 1,000 hours
(or part thereof) 3,000
Total 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 units Rs. 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 is
less by Rs. 2,800, it is profitable to make it on a second shift basis instead of buying it from
outside suppliers.
______________
Problem 13
A company manufacturing a highly successful line of cosmetics intends to diversify the product
line to achieve fuller utilization of its plant capacity. As a result of considerable research made
the 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 tubes
at 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 a
share 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 the
basis the following cost estimates have been developed:
Rs. per carton
Decision Making 21
Direct Materials 108
Direct wages 72
Overheads 54
Total costs 234
After a detailed market survey the company is confident that the production and sales of EMO
can 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 the
cost of the empty tubes if purchased from outside will result in a saving of 20% in material and
10% in direct wages and variable overhead costs of EMO. The price at which the outside firm is
willing to supply the empty tubes is Rs. 1.35 per empty tube. If the company desires to
manufacture empty tubes in excess of 3,00,000 tubes, a new machine involving an additional
fixed 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 empty
tubes at each of the three volumes of production of EMO namely, 3,00,000; 3,50,000 and
4,50,000 tubes.
(ii) At which volume of sales will it be economical for the company to install the additional
equipment for the manufacture of empty tubes?
(iii) Evaluate the profitability on the sale of EMO at each of the aforesaid three levels of
output based on your decision and showing the cost of empty tubes as a separate
element of cost.
Solution
(i) Working Notes:
Rs.
(1) Overheads for one carton i.e. 24 tubes 54
Therefore, per tube overheads: (Rs. 54/24 tubes) 2.25
Fixed overheads allocated for 3,00,000 tubes: Rs. 4,50,000
Rs. 4,50,000
Per tube fixed overheads: ------------------------- = Rs. 1.50
3,00,000 tubes
Therefore, variable overheads, per tube {Rs. 2.25 Rs. 1.50} = Re. 0.75
Rs.
(2) Direct wages per carton 72
Therefore, direct wages per tube: (Rs. 72/ 24 tubes0 3
(3) Direct materials per carton 108
Therefore, 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 without
EMO empty tube tube empty tube
Rs. Rs. Rs Rs.
Direct Materials 4.50 20 0.90 3.60
Direct wages 3.00 10 0.30 2.70
Decision Making 22
Variable 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 empty
Cost tubes are tubes are
Made purchased
Rs. 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 cost
of Rs. 3,82,500 whereas the total cost of purchase of tubes is higher, i.e., Rs. 4,05,000, the
company 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 total
additional fixed overheads of Rs. 30,000. the cost of making and buying the additional tubes
50,000 and 1,50,000 units of empty tubes will be as under:

Additional empty tubes________
50,000 tubes 1,50,000 tubes
Per tube Make Buy Make Buy
Rs. 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 is
lower than the cost of their manufacture. Therefore, if the company increases production to
3,50,000 tubes of EMO, 3,00,000 tubes should be made in the factory and additional 50,000
tubes 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 be
made 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 if
empty 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
Decision Making 23
Thus the company should sell 3,00,000 + 4,00,000 = 7,00,000 tubes of EMO per month to
warrant 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 tubes
Rs. Rs. Rs. Rs._______
Sales (Rs. 240/ 24 tubes) 10 30,00,000 35,00,000 45,00,000
Direct materials 3.60 10,80,000 12,60,000 16,20,000
Direct wages 2.70 8,10,000 9,45,000 12,15,000
Variable overheads 0.675 2,02,500 2,36,250 3,03,750
Empty tubes made 1.275 3,82,500 3,82,500 3,82,500
Empty tubes purchased 1.35 --- 67,500 2,02,500
________ _________ _________
Total costs 24,75,000 28,91,250 37,23,750
Profit 5,25,000 6,08,750 7,76,250


__________
Problem 14
A firm needs a component in an assembly operation. If it wants to do the manufacturing itself, it
would 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 10
lakhs respectively. If the firm had to buy the component from a supplier the component would
cost Rs. 9, 10, 11 lakhs and Rs. 14 lakhs respectively in each of the 4 years. However, the
machine would occupy floor space with could have been used for another machine. This letter
machine 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 the
machines and there are no other external effects. The cost of capital is 10% and PV factor for
each of the 4 years is 0.909, 0.826, 0.751 and 0.683 respectively. Should the firm make the
component or buy from outside
Solution
Evaluation of Make or Buy proposal
Year Present value When the component When the component
Factor at 10% is manufactured is bought
Cash outflow Present value Cash outflow Present value
(Capital cost, of cash outflows (cost of buying)
Manufacturing
Cost + opportunity
Cost
0 1.000 4 4.000 --- ---
1 0.909 6+2 7.272 9 8.181
2 0.826 7+2 7.434 10 8.260
3 0.751 8+2 7.510 11 8.261
4 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.
Decision Making 24
Note: The loss of Rs. 2 lakhs cash inflow for each of the 4 years due to inability of the firm to
operate another machine when it manufactures the component is to be treated as an opportunity
cost.
__________
Problem 15
Product 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. 5
per 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 or
manufactured.
Solution
Rs.
Selling price per unit of product A 50
Less: Marginal cost per unit __35
Contribution per unit 15
Contribution 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 hours Rs. 3 = Rs. 6
Real cost of producing one unit of product B
Rs.
Marginal cost per unit 5
Add: Contribution lost per unit __6
Total 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 16
A machine manufactures 10,000 units of a part at a total cost of Rs. 21 of which Rs. 18 is
variable. 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 a
component 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.
Solution
1
st
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 to
manufacture 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
Decision Making 25
Less: Contribution received on the utilization of machine time
10,000 units Rs. 2 __20,000
1,70,000
3
rd
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.) 1,90,0000
Less: 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.
Recommendation
Out of the above three alternatives, 3
rd
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, it
may think of utilizing the same to meet export orders at price lower than that prevailing in the
local market. This decision is made only when the local sale is earning a profit, i.e., where its
fixed expenses have already been recovered by the local sales. In such cases, if the export price
is more than the marginal cost, it is preferable to enter the export market. Any reduction in the
price 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 any
such adverse effect on local sales.
Problem 17
Perfect Pistons Ltd. Produces 60,000 pistons per annum for its percent company perfect Motors
Ltd. The pistons are sold to Perfect Motors at Rs. 200 per unit. The variable cost per piston is
Rs. 180. The animal fixed cost of perfect pistons Ltd. Is Rs. 15 lakhs and it is currently operating
at 60% capacity.
The company desires to respond to an export enquiry for 30,000 pistons of the type it is currently
manufacturing. 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, while
determining 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 certain critical auto components what will yield a 30% profit
on cost.
Recommend the bare minimum price that the company should quote, in order to break even
assuming:
(a) it sells the import license in the market.
(b) it imports component against the licence and sells them for profit.

Decision Making 26
Solution
Present Operating Results of Perfect Piston Ltd.
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 lakhs
Profit (Loss) Rs. (3 lakhs)
Increase in capacity utilization and the resultant and export sales should enable the company to
recover this loss.
(a) COMPUTATION OF RARE MINIMUM PRICE TO BREAK - EVEN
WHEN IMPORT LICENCE IS SOLD IN THE MARKET
Variable cost per piston Rs. 180.00
Add: Amount per piston towards recovering the present loss
(Rs. 3,00,000/ Rs. 30,000) ____10.00
Cost per piston 190.00
Less: Realization through export benefits:
Cash Assistance 10% on FOB
Duty Draw back 5% on FOB
Premium on Licence 10% on FOB
25% on FOB
i.e., 20% * of the cost per piston of Rs. 190 = __38.00
Hence, bare minimum FOB price to be quoted comes to 152.00
(b) COMPUTATION OF BARE MINIMUM PRICE TO BREAK EVEN WHEN IMPORT
LICENCE IS USED TO IMPORT AUTO COMPONENTS AND SELL THEM FOR PROFIT
Cost per piston (as per (a) above) Rs. 190.00
Less: Realization through export benefits
Cash Assistance 10% on FOB
Duty Drawback 5% on FOB
Profit on sales of imports
30% 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 54,00,000
Add: Loss to be recovered __3,00,000
Total 57,00,000
(a) The following equation can be formed and solved for determining the price when import
licence 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 7,500x
or, 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)}
Decision Making 27
or, 30,000x = Rs. 57,00,000 5,400x
x = Rs. 161.02
Bare minimum F.O.B. price to be quoted is Rs. 161.02 per piston.
Problem 18
A firm gives the following data:
Selling price Rs. 6 p.u. Fixed expenses Rs. 15,000
Total 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 order
or not.
Solution
Break-even point = ----------------------------------
=
4 . 6 .
000 , 15 .
Rs Rs
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 will
fetch 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 local
selling price of Rs. 6 per unit.
_________
Problem 19
X 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 applicable
export incentives) work out as follows:
Capacity utilization % 70 80 90 100
FOB 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 FOB
Source B 10,000 units at. Rs. 52 per unit FOB
Source 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.
Solution
X Ltd.
Statement showing differential cost at different capacity utilization Levels
Installed capacity 1,00,000 units.

Fixed expenses
Contribution
Decision Making 28
Capacity production at FOB unit Total Differential Per unit
Utilization different levels cost costs costs differential
Of capacity costs
Utilization
Percent units Rs. Rs. Rs. Rs.
70 70,000 97 67,90,000 --- ---
80 80,000 92 73,60,000 5,70,000 57
90 90,000 87 78,30,000 4,70,00 47
100 1,00,000 82 82,00,000 3,70,000 37
Statement showing Gain or Loss on Accepting the Various Export orders
Export Export Capacity Differential cost FOB Sales Gain/
Order order utilization per total price revenue (Loss)
(Source) (unit) per cent unit per from the
unit export
Rs. 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 Nil
5,000 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 export
orders are accepted. If the company accepts exports only for one or two of the three sources, it
will 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 incurred
b) Possible decrease in selling price due to increase in production
c) 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 have
to be taken into account. If a branch office is to be closed down and if the branch is given a
marginal contribution sufficient to cover fixed expenses the contraction may lead to a loss under:
Problem 20
Branch B: Sales Rs. 20,000
P/V ratio 20%
Marginal contribution Rs. 4,000
Fixed expenses of the branch Rs. 3,000
Decision Making 29
The branch is giving an extra contribution of Rs. 1,000. if it is closed, the fixed expenses saving
is Rs. 3,000 whereas the contribution lost is Rs. 4,000. Hence it is not advisable to contract the
business by closing down the branch.
Problem 21
K Ltd. manufactures and sells a range of sports goods. Management is considering a
proposal for an advertising campaign, which would cost the company Rs. 3,00,000. The
marketing department has put forward the following two alternative sales budgets for the
following year:

Products (000 units)
A B C D
Budget 1 Without Advertising 216 336 312 180
Budget 2 without Advertising 240 373 342 198
Selling prices and variable production costs are budgeted as follows:
Products (Rs. Per units)
A B C D
Selling prices 11.94 14.34 27.54 23.94
Variable production costs:
Direct material 5.04 6.60 15.24 12.48
Direct labour 2.04 2.04 3.36 3.18
Variable 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 Total
Selling price per unit (Rs.) 11.94 14.34 27.54 23.94
Less: Variable cost p.u. (Rs.) _7.80 _9.36 _19.80 _16.74
Contribution p.u. (Rs.) 4.14 4.98 7.74 7.20
Time 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 8
Ranking IV I III II
Budget 1 (Mc. Hrs.) 1,29,600 2,01,600 3,12,000 1,62,000 8,05,200
Budget 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 a
shortfall of 72,000 hours (8,87,400 8,15,000) to meet Budget 2, targets. These additional
Decision Making 30
machine hours requirement may be met by way of purchasing either additional units of product A
or C, so that the extra cost of buying machine hours in minimum.
Products A C
Additional 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 4.20
Hours (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, therefore
it is advisable to purchase 72,400 units of product C and thus meet fully the gap in the
machine hours requirement i.e. 72,400. The extra cost of buying 72,400 machine hours
would come to Rs. 3,04,080 (72,400 hrs Rs. 4.20)
(i) Evaluation of investment in advertisement campaign
Products
A B C D Total
Additional sales volume
(000 units): (A) 24 36 30 18
units contribution (Rs. 000) : (B) 4.14 4.98 7.74 7.20
Additional contribution
(Rs. 000) : (B A) 99.36 179.28 232.20 129.60 640.44
Less: Extra machine buying cost
(Rs.000) --- --- --- --- 304.08
Less: cost of Advertisement
(Rs. 000) --- --- --- --- _300.00
Additional 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 1,44,000
B 2,23,200
C 2,69,600
D __1,78,200
Total __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 revenue
exceeds 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 of
operation, the company had experienced a gradual increase in sales volume, and the current
annual growth in sales of 5% is expected to continue into the foreseeable future. The plant is
now producing at its full capacity of one lakh hot plates.
Decision Making 31
At the monthly management advisory committee meeting, amongst other things, the plan of
action for next year was discussed.
Managing director proposed two alternatives. First, operations could be continued at full capacity
and with the existing facilities an output of one lakh hot plates at a selling price of Rs. 100 per
unit could be maintained. Secondly, production and sales could be increased by 5% to take
advantage of the rate of expansion in demand for the product. But this could increase cost, as to
achieve 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 director
was of the view that it was not enough for the company to maintain merely the present share of
the total market. A larger share of the total market should be obtained. For that, the company
should increase the production by 10% through a modest expansion of plant capacity. In order
to 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 and
volume. With this end in view, he suggested that the company should straight away embark on
an expensive modernization programme which will initially increase volume by 20%. The entire
output 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 the
companys competitors. They right also expand in order to produce more and sell at lowest
prices suppose this happened, he wanted also the financial effects of the proposals of the works
Director and the marketing director, if in those proposals, the increase in sales were to be only
half 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 would
remain 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 and
some savings from purchase of materials, it is estimated that the ratio of variable cost to
sales 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 Directors
proposals.
Decision Making 32
(d) Comments on the price elasticity of demand for the companys product and your
suggestions 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.

Proposals
Managing Managing Works Works Marketing Marketing
Directors Directors Directors Directors Directors Directors
1
st
proposal 2
nd
proposal 1
st
proposals 2
nd
proposal 1
st
proposal 2
nd
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 1,10,000
Unit selling
Price (Rs.) 100 100 95 95 90 90
Total turnover
(Rs. In lakhs) 100.00 105.00 104.50 99.75 108.000 99.00
Unit contribution
(Rs.) 50 45 47.50 47.50 46.80 46.80
Total contribution
(Rs. In lakhs) 50 47.25 52.25 49.875 56.16 51.48
Fixed cost
(Rs. In lakhs) 30 30.25 32.25 32.25 35.16 35.16
profit (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 75,128
Margin of safety
In 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 proposals
raise the break-even point further. In an uncertain market, if in the proposals of works Director
and the marketing Director, only half the increase is achieved, the margin of safety will be lower
than 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 other
proposals.
(c) The company had already reached its full capacity. As a short-term measure, the view, neither
of the proposals can be considered to be satisfactory. Both the proposals of the managing
Director do not provide a lasting solution. Though the second proposal maintains the market
share, it results in less profit, both in quantum and percentage. As the capacity has already been
reached there is an urgent necessity for the Managing Director to address himself to long range
objectives 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 notions
on price. They think that if the volume increases in order to sell the increased volume, price has
to be lowered. No serious study seems to have been made on the price elasticity of demand for
the companys product. On the other hand, we have been told that there is a steady 5% annual
growth in demand, which means that the prices need not be reduced, only more market share
has to be obtained. For incremental production, differential pricing in certain special markets has
to be resorted to; if this is not possible, the increased production can be sold under a different
band name with a different price (A static cost structure, more or less, has been assumed). To
Decision Making 33
beat competition, a better product has to be put in the market and cost reduction offered through
value analysis, etc.
(e) The expansion scheme envisaged have to be properly tested for profitability by feasibility study
reports, etc. Source of financing the expansion has to be determined. The financial implications
of share issue or borrowed funds have to be gone through. Long range objectives have to be
defined 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 another
instead. Generally decision is made on the basis of contribution of each product. Other things
being the same the product which yields the highest contribution is best one to produce. But, if
there 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 a
decision. For example, in an undertaking the availability of machine capacity is limited and the
machine hours required for one unit of the two products are different. In such cases the
contribution is to be linked with the machine hour and the product which yield the highest
contribution per machine hour is to be preferred for taking decision.
Problem 23
A company manufactures two products EXE and WYE, which pass through two of its
departments exclusively used for them. A market research study conducted by the company
reveals 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 WYE
Selling price per unit 375 540
Costs:
Department 1:
Direct materials 58 100
Direct labour 5 hours 50 7.5 hours 75
Department 2:
Direct materials 21 26
Direct labour 7.5 hours 90 10 hours 120
Overheads: Department 1 Department 2
Variable overhead rate per direct labour Rs.2.40 Rs.3.60
Hour
Fixed overheads Rs.5, 00,000 Rs.10, 00,000
Budgeted direct labour hours 1,75,000 2,80,000
Since the quantity which can be sold exceeded the production capacity, the company has been
considering the use of sub-contracting production facilities. Accordingly, when tenders were
floated, two contractors responded as under:
Contractor DS offers to produce upto a maximum of 17,500 units of EXE or 14,000 units of WYE
in a year for the type of work done by department 1 of thee company. The price charged by DS is
Rs.138 per unit of EXE and Rs.212 per unit of WYE. These prices included the cost of direct
materials 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 year
for the type of work done by department 2 of the company. The price charged by DW is Rs.150
per unit of EXE and Rs. 192 per unit of WYE. These prices included the cost of direct materials
used in department 2 of the company.
Required:
Decision Making 34
(1) If the company does not wish to use the sub-contracting facility, which of the two product
and in what quantity should be produced and sold by the company by using its own
manufacturing 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 the
profits. 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 1
Number of units produced 35,000 23,333
In the department 1 (1,75,000 hrs./5 hrs.) (1,75,000hrs./7.5 hrs.)
Department 2
Number of units produced in 37,333 28,000
The department 2 (2,80,000 hrs./7.5 hrs.) (2,80,000 hrs. /10 hrs.)
Maximum number of units 35,000 23,333
Which can be produced &
sold by using the available
hours in the two
departments.
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 is
maximum , 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 23,333
Sub-contracting the facility required in Department 1 2,333 4,667
(in units)
Sub-contracting the facility required in Department 1 1,167 3,500
And 2 (units)
Computation of profit :
Contribution per unit on internally produced units 117 165
(Rs.)
(Refer to working notes 1)
Contribution per units when sub-contracting facilities 99 146
Of
Decision Making 35
Department 1 were utilised(Rs.)
(Refer to working note 2)
Contribution per unit, when sub-contracting facilities 87 136
Of 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 15,00.000
Profit 29,27,496 35,07,328
Decision: 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:
Product
EXE WYE
-------------------------------------------------------
. Rs. Rs.
Selling price units:(A) 375 540
Department-1
Direct materials 58 100
Direct labour 50 75
Variable overheads 12 18
(5hrs. X Rs.2.40) (7.5hrs. X Rs.2.40)
Manufacturing cost in department 1(B) 120 193
Department-2
Direct materials 21 26
Direct labour 90 120
Variable overheads 27 36
(7.5hrs.X Rs.3.60) (10 hrs X Rs. 3.60)
Manufacturing cost in department 2: 138 182
Total variable cost of manufacturing per 258 375
Unit: (D)= }
Contribution per unit :{(A) (D)} 117 165
2. Contribution per unit: (When the facilities of department 1, were sub-contracted but that of
department 2 were utilised internally)
Rs. Rs.
Manufacturing cost of sub-contracting of 138 212
Department 1
Manufacturing cost of internal department 2 138 182
Total variable cost of manufacturing per unit 276 394
Contribution 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 138 212
department 2
Manufacturing cost of sub-contracting 150 192
department 2
Total variable cost of manufacturing per 288 404
Unit
Contribution per unit 87 136
(Rs.375 - Rs.288) (Rs.540 - Rs.404)
Decision Making 36
4. Total contribution :
Rs. Rs.
Total contribution on internally 40,95,000 38,49,945
produced units (35,000 units x Rs.117) (23,333 units x Rs.165)
Total contribution when 2,30967 6,81,382
department 1 services were sub- (2,333 units x Rs.99) (4,667 units x Rs.146)
contracted ------------------------ ---------------------
44,27,496 50,07,327

Problem 24
X Ltd. has two factories, one at Lucknow and another at Pune producing 7,200tonnes and
10,800 tonnes of a product against the maximum production capacity of 9,000 and 11,880
tonnes respectively at Lucknow and Pune.
10% of the raw material introduced is lost in the production process. The maximum quantity of
raw material, available locally are 6,000 and 13,000 tonnes at Rs. 720 and Rs. 729 per tonne at
Lucknow and Pune respectively. For the additional needs a supplier of Bhopal is ready to supply
raw 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 fixed
costs 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 Pune
factory 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 change
in present total output of 18,000 tonnes whereby the company may earn optimum profit.
Solution
Statement of cost per tonne and net profit earned in respect of each factory
Lucknow Pune
Present 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 32.94
Fixed costs (Rs. In lakhs) 18.00 24.84
Total cost (Rs. In lakhs) (B) 99.36 145.26
Cost per tonne (Rs.) : (C) = [(B)/(A)] 1,380 1,345
Selling price (Rs.) per tonne : (D) 1,450 1,460
Net profit per tonne (Rs.) [(D)-(C)] 70 115
Total net profit (Rs. In lakhs) 5.04 12.42
(70 7,200 tonnes) (115 10,800 tonnes)
Total profit of the company = Rs. 17.46 lakhs
(Rs. 5.04 + Rs. 12.42)
Alternative production plan to earn optimum profit
Lucknow Pune
Maximum production capacity (tonnes) 9,000 11,880
Present production (tonnes) 7,200 10,800
Rs. Rs.
Decision Making 37
Cost per tonne of output:
Cost per tonne of output manufactured from locally 800 810
Purchased raw material : (A)
(Refer to working note 2)
Cost per tonne of output manufactured from material 880 880
Purchased from Bhopal : (B)
(Refer to working note 3)
Other variable cost (Rs.) : (C) 310 305

,
`

.
|
tonnes
lakhs Rs
200 , 7
32 . 22 .

,
`

.
|
tonnes
lakhs Rs
800 , 10
94 . 32 .
Selling price per tonne (Rs.) : (D) 1,450 1,460
Contribution 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:
Priority
Pune factory (Local purchase of raw materials) 1
st
Lucknow factory (Local purchase of raw material) 2
nd
Pune factory (Raw material purchased from Bhopal) 3
rd
Lucknow factory (raw material purchased from Bhopal) 4
th
Suggested alternative production plan
Output (in tonnes)
Production Raw material Lucknow Pune Total
Priority input (in tonnes)
1. 11,700 tonnes 13,000 --- 11,700
11,700
2. 5,400 tonnes 6,000 5,400 ---
5,400
3. (11,880 11,700) = 180 tonnes 200 --- 180
180
4. 720 tonnes balancing figure
(18,000 17,280 tonnes) __800 720 ---
720
20,000 6,120
11,880 18,000
Working notes:
Lucknow Pune
1.Present production output (tonnes) 7,200 10,800
Total raw material required for present production (tonnes) 8,000 12,000

,
`

.
|
90
100
200 , 7 x
,
`

.
|
90
100
800 , 10 x
Raw Material procured locally (tonnes) 6,000 12,000
Raw material procured from Bhopal (tonnes) 2,000 ---
Cost of raw material purchased locally and from
Bhopal (Rs. In lakhs) 59.04 87.48
(720 6,000 (12,000 729)
+ 792 2,000)
2.Cost per tonne of output manufactured from locally
Purchased raw material (Rs.) 800 810
Decision Making 38
90
100
720 x
90
100
729 x
3.Cost per tonne of output manufactured from material
Purchased from Bhopal (in Rs.) 880 880

,
`

.
|
90
100
729 . x Rs
Problem 25
A company manufactures two products, A and B using imported raw materials. The selling price
of these products are: A Rs. 144, B Rs. 216. The standard cost data are as under:
Product Product
A B
Rs. Rs.
Raw Materials P 15 20
Q 5 20
Direct Wages @ Rs. 4/- per hour
Department 1. 24 36
2. 12 24
3. 36
4. 48
Variable Overheads 16 14
Fixed 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 engaged
in each department is given below
Department 1 2 3 4
No. of workers 45 24 27 36
Required :-
(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 department
to 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 of both the imported raw
materials in total is limited to Rs. 1,80,000.
Solution
Note-1: application of bottleneck to identify short supply Dept
Department 1 2 3 4 Total
(a) Capacity (LHR) 1,08,000 57,600 64,800 86,400
For Product A
(b) Hr./unit 6 3 9 --
(c) Max. production 18,000 19,200 7,200 -- Feasible
(a b) -7,200
for production B
(d) hr./unit 9 6 -- 12 feasible
(e) units 12,000 9,600 -- 7,200 7,200
(f) Hr. req. for 1,08,000 64,800 64,800 86,400
feasible production
7,200 (b+ d)
(g) short supply x 7,200 x x
(f-a)
Decision Making 39
Note-2: Computation of contribution per lt. Factor & rank
Contribution/hr. of Dept 2
Contribution/unit Rs 36 54
Hour/unit 3 6
Contribution/hour Rs 12 9
Rank I II
(a) statement of Allotment & Profit
Unit contribution/unit
Hrs available in Dept-2 57,600
Less: R-I A: (7,200 3) 21,600 7,200 36
B 36,000/6 6,000 54 _______
5,83,200
Less: Fixed cost 2,50,000
3,33,200
(ii) (a) One product to produce: select the product with highest contribution
contribution from A : 7,200 36
B : 7,200 54 Maximum
Product-B should be produced
(ii) (b) One product with 2 limiting factor : apply the concept of bottleneck
Product Feasible prod. Feasible prod. Feasible Contribution/unit Total
On cap. (LHR) on mat. Basis Production Rs Rs.
A 7,200 1,80,000 20 = 9,000 7,200 36 2,59,200
B 7,200 1,80,000 40 = 4,500 4,500 54 2,43,000
So Product A should produced.
Problem 26
Sweet Dreams Ltd. manufactures and markets three products A, B and C in the state of
Haryana and Rajasthan. At the end of first half of 1996-97 the following absorption based
profit statement has been drawn by the accountant.:
(Rs. In lakhs)
Haryana Rajasthan Total
Sales 3,000 900 3,900
Manufacturing cost of sales 2,331 699 3,030
Gross profit __669 201 870
Administration expenses: (A) 120 36 156
Selling expenses : (B) __184 169 353
Total expenses __304 205 509
Net profit 365 (-) 4 361
(A) The expenses are constant and common to both the states. They stand allocated on the
basis of sales.
(B) The expenses are semi-fixed but specially relate to the respective state.
Decision Making 40
The management is worried to note that the decision taken to market the products in
Rajasthan to utilize idle capacity has proved wrong and wish to cover only Haryana state.
The in charge of marketing division is not satisfied with the above way of profit presentation.
He is of the firm opinion that sales effected in the state of Rajasthan is contributing profits.
For the next half year he expects no increase in demand in Haryana while for Rajasthan he
anticipates to sell products B or C more by 50% of existing sales. This will utilize the idle
capacity in full.
The product wise relevant details for the first half of 1996-97 are:
A B C
Sales (in Rs. 000):
Haryana 1,200 900 900
Rajasthan 300 300 300
Variable costs (as a % on sales):
Manufacturing 40 35 30
Selling 3 2 2
Specific fixed manufacturing expenses
(in Rs. 000) 570 470 610
You are required to:
(a) Prepare a state-wise profit statement for the first half of 1996-97 using contribution
approach. Also offer your views on the contention of the management and
opinion expressed by in charge of marketing division.
(b) Prepare a product wise profit statement for the same period using contribution
approach.
(c) Submit your well throughout recommendation as to which product should be
produced to utilize idle capacity.
Solution
Working notes:
1. Variable manufacturing and selling costs (in Rs. 000)
Products Sales_______ Mfg. Costs_______ Selling costs
Haryana Rajasthan % of Haryana Rajasthan % of Haryana Rajasthan
Sales sales
A 1,200 300 40 480 120 3 36 9
B 900 300 35 315 105 2 18 6
C 900 300 30 __270 __90 2 __18 __6
Total: 1,065 315 72 21
2. Specified fixed expenses (in Rs. 000)
________ Manufacturing_________ Selling______________
Haryana Rajasthan Total Haryana Rajasthan Total
Total manufacturing
Cost of sales 2,331 699 3,030 184 169 353
Less: Variable manufacturing
And selling costs
(Ref. To working note 1) _1,065 __315 _1,380 ___72 ___21 ___93
Specified fixed costs 1,266 384 1,650 112 148 260
3. Product wise specified fixed selling expenses (in Rs. 000):
Total A B C
Fixed selling expenses of Haryana
And Rajasthan apportioned in proportion
Decision Making 41
Of their sales, viz., (15:12:12) 260 100 80 80
(a) State wise profit statement for the first half of 1996-97 using contribution approach.
(Rs. In lakhs)
Haryana Rajasthan
Total
Sales: (1) 3,000 900 3,900
Variable costs:
Manufacturing 1,065 315 1,380
(Ref. Working note 1)
Selling ___72 ___21 ___93
(Ref. Working note 1)
Total: (II) 1,137 336 1,473
Contribution: [(I)-(ii)] = (A) 1,863 564 2,427
Specified fixed cost:
Manufacturing 1,266 384 1,650
(Refer to working note 2)
selling __112 __148 __260
Total : (B) 1,378 532 1,910
Net contribution : [(A-B)] 485 32 517
Less: common fixed costs (Administration) __156
Net profit 361
P/V ratio (in %) (C/S 100) 62.1 62.67 62.23
Views: The contention of the management is not valid i.e. the state of Rajasthan shows Rs.
32,000 as contribution to meet the common fixed costs. In case only Haryana state is covered
the net profit of the concern would go down from Rs. 3,61,000 to Rs. 3,29,000.
In view of the above position, the statement made by the in charge of the marketing division
appears to be correct.
(b) Product wise profit statement for the first half of 1996-97 using contribution approach
(Rs. In 000)
A B C Total
Total sales of Haryana and Rajasthan: (I)1,500 1,200 1,200 3,900
Variable costs:
Manufacturing:
(1,500 40%)
(1,200 35%)
(1,200 30%) 600 420 360 1,380
Selling:
(1,500 3%)
(1,200 2%)
(1,200 2%) ___45 24 24 93
Total (III) 645 444 384 1,473
Contribution: (I-II) = (III) 855 756 816 2,427
Specified fixed cost:
Manufacturing 570 470 610 1,650
Selling
(Ref. To working note 3) 100 80 80 260
Total (IV) 670 550 690 1,910
Net contribution: [(III-IV)] 185 206 126 517
Less: Common fixed administration exp. ___156
Decision Making 42
Net profit __361
P/V ratio (contribution/Sales) 100 57% 63% 68% 62.23%
(c) Recommendation for utilizing idle capacity:
A review of the above P/V ratios shows that the increase of output of product C in Rajasthan
is the best. The increase of production after utilizing the idle capacity in Rajasthan to the
extent of Rs. 1,50,000 (i.e. 50% of Rs. 3,00,000) would increase the contribution of the
company in the state of Rajasthan by Rs. 1,02,000 (68% Rs. 1,50,000).
----------------------------
Problem 26
There are two product A and B. the selling prices, variable costs and machine hours required
per unit are:
A B
Selling price (Rs.) 2.00 2.50
Variable cost (Rs.) 1.00 1.50
Machine hours 2 1
Find the more profitable product when plant capacity is limited.
Solution
A B
Selling price (Rs.) 2.00 2.50
Less: Variable cost (Rs.) 1.00 1.50
Contribution (Rs.) 1.00 1.00
Machine hours required 2 1
Contribution per machine hours (Rs.) 0.50 1.00
From the above it is evident that the contribution of product A & B in absolute terms is the same.
However, when we link this contribution with the machine hour which is a key factor, the product
B gives more profit. As such product B is to be given preference over product A.
________
Problem 27
A firm manufactures 5 products using the same raw materials which is in short supply. By
examining the following information, show which product is to be chosen so that the profit can be
the maximum.
Products
A B C D E
Sales (units) 1,500 2,500 1,600 2,000 2,200
Production (units) 2,000 3,000 1,500 2,000 2,000
Possible sales 1,500 2,500 1,500 2,000 2,000
Selling price p.u. 4.00 3.50 1.50 1.00 3.00
Marginal cost per unit 3.00 2.00 1.25 0.75 2.50
Contribution p.u. 1.00 1.50 0.25 0.25 0.50
Raw material required (kgs.) 2 8 3 5 2
Contribution against 1 kg. Of
Raw material 0.50 0.19 0.083 0.05 0.25
Solution
When raw material is in short supply, the order in which production is to be undertaken is A, E, B,
C, & D based on contribution per unit of the key factor.
Decision Making 43
Let us suppose that 5,000 kgs. Of raw material is available. Our production pattern will be as
under:
Product Sales Material Total Contribution Total
Units per unit material per unit contribution
Kgs. Kgs. Rs. Rs.
A 1,500 2 3,000 1.00 1,500
E 1,000 2 2,000 0.50 500
5,000 2,000
Although the unit contribution of product B is the largest, when the key factor is raw material
supply, it ranks third in priority for manufacture, because it consumes more raw material.
________
Problem 28
(a) Alcos Ltd., manufactures and sells four types of products under the brand names A, B, C
and D. the sales mix in value comprises 33-1/3%, 41-2/3%, 16-2/3% and 8-1/3% of A, B, C
and D respectively. The total budgeted sales (10%) are Rs. 60,000 per month.
Operating costs are:
Variable cost:
A 60% of selling price
B 68% of selling price
C 80% of selling price
D 40% of selling price
Fixed costs Rs. 14,700 per month.
Calculate the break-even point for the products on an overall basis.
(b) it has been proposed to change the sales mix as follows, the total sales per month
remaining Rs. 60,000.
A 25%
B 40%
C 30%
D 5%
Assuming that the proposal is implemented.
Calculate the new break-even point.
Solution
(a)
Products__________________
A B C D Total
Sales mix 33 1/3% 41 2/3% 16 2/3% 8 1/3% 100%
Rs. Rs. Rs. Rs. Rs.
Sales 20,000 25,000 10,000 5,000 60,000
Variable cost 12,000 17,000 8,000 2,000 39,000
Contribution 8,000 8,000 2,000 3,000 21,000
P/v ratio = 100 x
Sales
on Contributi
=
% 35 100
000 , 60 .
000 , 21 .
x
Rs
Rs

Break-even point (Sales value) = 000 , 42 .
35 . 0
700 , 14 .
/
cos
Rs
Rs
Vratio P
ts Fixed

(b) The revised contribution after change in sales mix
Products
A B C D Total
Sales mix 25% 40% 30% 5% 100%
Decision Making 44
Rs. Rs. Rs. Rs. Rs.
Sales 15,000 24,000 18,000 3,000 60,000
Variable costs 9,000 16,320 14,400 1,200 40,920
Contribution 19,080
P/V ratio =
100
000 , 60 .
080 , 19 .
x
Rs
Rs
= 31.8%
Break-even point (Sales value) =
318 . 0
700 , 14 . Rs
= Rs. 46,226
_______________
Problem 29
A firms operations are at present performed by hand. It has a proposal to install a new machine
which can produce at a faster rate. Following information is available. Advise the management
about the profitability of mechanization.
Hand machine
Production in units per hour 1 2
Marginal cost per unit (Rs.) 18 16
Additional fixed cost per unit (Rs.) --- 3
Total cost per unit (Rs.) 18 19
Selling price per unit (Rs.) 24 24
Solution
Let us analyze the figures as under:
Hand Machine
Rs. Rs.
Selling price per unit 24 24
Less: Marginal cost per unit 18 19
(Including additional fixed cost)
Contribution per unit 6 5
Contribution per hour 6 10
If there is a great demand for the products, it is advisable to mechanize because the gross
margin per hour is more than that under hand operation.
If however, there is idle capacity and there is an under absorption of fixed overheads to the
extent of Rs. 3 per unit the total cost will be Rs. (19+3) = Rs. 22 leaving a contribution of Rs. 2
per unit. The contribution per hour will, therefore, be Rs. 4 which is less than that of obtaining
under hand operation. Hence mechanization will not be advisable under these circumstances.
__________
Problem 30
An engineering company is engaged in producing four products through operations at welding
and pressing departments. Product W1, W2 are produced by welders in the welding department
whereas products P1 and P2 are produced by press-operators in the pressing department. Due
to specific skill requirements, the welders and press-operators can only work in their own
department.
The following relevant data are available in respect of the products:
_____ Products
W1 W2 P1 P2
Hours required per unit 4 4 5 2
Selling price per unit (Rs.) 48 50 77 69
Direct material cost per unit (Rs.) 18 22 32 44
Decision Making 45
Direct labour hourly rate (Rs.) 4 4 4 4
Variable overhead rate per unit (Rs.) 2 2 3 3
The company incurs Rs. 50,000 p.a. towards fixed costs. The maximum available hours are
20,000 and 16,000 for welding and pressing departments respectively.
The demands on fluctuating but the minimum demands which are to be met as per
managements decision are 2,000 units of W1, 2,500 units of W2, 1,800 units of P1 and 2,200
units of P2.
The production manager suggests that the welders and press-operators can be trained to
perform both welding and pressing jobs so that excess demand of any of the products can be
met. This decision is going to increase the burden of fixed costs by Rs. 5,000 p.a.
Prepare the profitability statement for optimum product-mix and recommend with reasons and
appropriate working whether it is advisable to train the welders and press-operators as
suggested by the production manager.
Solution
Optimum product mix before training
Department Welding Pressing
Maximum hours 20,000 hours 16,000 hours
Product W1 W2 P1 P2
Selling price per unit (Rs.) 48 50 77 69
Less: Variable cost
Material (Rs.) 18 22 32 44
Labour (Rs.) 16 16 20 8
Variable overhead (Rs.) 2 2 3 3
Total variable cost (Rs.) 36 40 55 55
Contribution per unit : (A) 12 10 22 14
Labour hours per unit: (B) 4 4 5 2
Contribution per hour (Rs.) (A B) 3 2.5 4.4 7
Ranking I II II I
Minimum production (units) 2,000 2,500 1,800 2,200
Labour hours needed 8,000 10,000 9,000 4,400
Labour hours used for
Each department 8,000+ 10,000 = 18,000 9,000 + 4,400 = 13,400
Balance hours available 20,000 -18,000 =2,000 16,000 13,400 = 2,600
Product to be produced W1 P2
Units to be produced 2,000 4 = 500 2,600 2 = 1,300
W1 W2 P1 P2
Hence, product-mix 2,000 +500 2,500 1,800 2,200 + 1,300
= 2,500 = 3,500
Profitability statement before training
Product Product-mix Hours Contribution
Units per unit Total per hours Total
Rs. Rs.
W1 2,500 4 10,000 3.00 30,000
W2 2,500 4 10,000 2.50 25,000
20,000 55,000
P1 1,800 5 9,000 4.40 39,600
P2 3,500 2 7,000 7.00 49,000
16,000 88,600
Total 36,000 1,43,600
Less: Fixed cost 50,000
Net profit 93,600
Decision Making 46
Optimum product-mix after training
After training the capacity will be taken as a whole at 36,000 labour hours because of
interchangeability of available labour force. The ranking will be done on the basis of contribution
per hour among all the four products, since a workman is trained to work in any of the
departments.

Production W1 W2 P1 P2
Maximum hours 36,000 hours as a whole
Hours needed for minimum production 8,000 10,000 9,000 4,400
(Total hours = 31,400 hours)
Balance hours (36,000 31,400 hours = 4,600 hours)
Product priority (Ranking) III IV II I
Product in balance hours P2 (I rank) 4,600 2= 2,300 units
Product-mix (units) 2,000 2,500 1,800 2,200 +
2,300
Profitability statement after training
Product product-mix Hours contribution
units per unit total per hour Amount
Rs. Rs. Rs.
W1 2,000 4 8,000 3.00 24,000
W2 2,500 4 10,000 2.50 25,000
P1 1,800 5 9,000 4.40 39,600
P2 4,500 2 _9,000 7.00 __63,000
36,000 1,51,600
Less: Fixed costs 55,000
Net profit 96,000
Recommendation:
Since the net profit after training will be more by Rs. 3,000 (Rs. 96,600 Rs. 93,600), it is
advisable to train the welders and press operators as suggested by the production manager.
___________
Problem 31
Veejay Ltd. makes and sell two products, Vee and Jay. The budgeted selling price of Vee is Rs.
1,800 and that of jay is Rs. 2,160. Variable costs associated with producing and selling the Vee
are Rs. 900 and with Jay Rs. 1,800. Annual fixed production and selling costs of Veejay Ltd. are
Rs. 88,000.
The company has two production/sales option. The Vee and Jay can be sold either in the ratio of
two Vees to three Jays or in the ratio of one Vee to two Jays.
What will be the optimal mix and why?
Solution
Selection of best optimal mix
Products_______________
Vee Jay
Rs. Rs.
Budgeted selling price p.u. 1,800 2,160
Less: Variable cost p.u. __900 1,800
Contribution p.u. __900 __360
(I) Production/sales option : (2 units of Vee and 3 units of Jays)
Total contribution under 1
st
option
= (2 units Rs. 900+ 3 units Rs. 360)
= Rs. 1,800 + Rs. 1,080 = Rs. 2,880
Annual fixed production & selling costs
Total contribution under 1
st
option
Decision Making 47
Break-even point = -------------------------------------------------------
=
880 , 2 .
000 , 88 .
Rs
Rs
= 30.56 (Set of 5 units each)
Products_______________
Vee Jay Total
Break-even point (units) = 30.56 2 units 30.56 3 units
= 61.12 units = 91.68 units
= 61 (units approx) = 92 (units approx)
Break-even sales (Rs.) = 1,09,800 = 1,98,720 3,08,520
(61 units Rs. 1,800) (92 units Rs. 2,160)
(II) Production/Sales option: (1 unit of Vee and 2 units of Jays)
Total contribution under 2
nd
option
= (1 unit Rs. 900 + 2 units Rs. 360)
= Rs. 900+ Rs. 720
= Rs. 1,620
Break-even point
=
620 , 1 .
000 , 88 .
Rs
Rs
= 54.32 (sets of 3 units each)
Products_______________
Vee Jay Total
Break-even point (units) 54.32 1 units 54.32 2 units
= 54 (unit approx.) = 109 (units approx)
Break-even sales (Rs.) = 97,200 = 2,35,440 3,32,640
(54 units Rs. 1,800) (109 units Rs. 2,160)
Note:
The given amount of annual fixed production and selling cost is such that it fails to determine the
exact figure of break-even point under two given sales options. The approximations made in the
above solutions under option I, at break-even level over recovers Rs. 20; whereas under option II
of the solution there is an under recovery of fixed cost to the extent of Rs. 160.
_________
Decision & reasoning:
Option I is preferred over option II, as it results in a lower level of sales to reach break even
(because of higher average contribution per unit sold). The average contribution per unit (under
option I) is Rs. 576 (Rs. 2,880/5 units) and (under option II) it is Rs. 540 (Rs. 1,620/3 units).
Option I contains a higher percentage (40% as against 33 1/3%) of more profitable products.
Problem 32
ZED Ltd. manufactures two products P and Q and sells them at Rs. 215 and Rs. 320 per unit
respectively. The variable costs per unit are as under:
Product-P Product-Q
Rs. Rs.
Raw materials:
Decision Making 48
Material- P 22.00 28.00
Material- Q 8.00 32.00
Direct wages (Rs. 6 per labour hour ) :
Department - A 36.00 54.00
Department - B 18.00 36.00
Department - C 54.00 -
Department - D - 72.00
Variable overheads 23.00 14.30
The company products raw materials against import license. The company operates at single
shift a day of 8 hours for 300 days in a year. The number of workmen engaged are 30, 16,18 &
24 in departments A, B, C and D respectively. Neither the workers are subject to transfer from
one department another nor any new recruitment is possible at present. Fixed costs are Rs.
12,000 per month.
You are required to find out the following:
(a) The product-mix to yield maximum profit.
(b) The most profitable product if only one product is to be manufactured. Whether the Solution
will differ if license to import raw materials is released only for Rs. 1,80,000.
Solution
Working notes:
1. Computation of total labour hours available
Departments No. of workmen Days Hrs./day Total hours
(a) (b) (c) (d) (e) = (b) (c) (d)
A 30 300 8 72,000
B 16 300 8 38,400
C 18 300 8 43,200
D 24 300 8 57,600
2. Computation of hours required per unit of each product
Department Product P Product Q
Wages Wages/hr. Hrs. Wages Wages/hr. Hrs.
(Rs.) (Rs.) (Rs.) (Rs.)
(a) (b) (c)=(a)/(b) (d) (e) (f) = (d)/(e)
A 36 6 6 54 6 9
B 18 6 3 36 6 6
C 54 6 9 -- --- --
D --- --- --- 72 6 12
____ ____
Total hours per unit __18 __27
3. Statement showing maximum output permissible
Departments Hours Product P_____ Product Q
available hrs. Required / Maximum Hrs. required/ Maximum
units output in units output in
units units
(a) (b) (c) =(a)/(b) (d) (e) = (a)/(d)
A 72,000 6 12,000 9 8,000
B 38,400 3 12,800 6 6,400
C 43,200 9 4,800* -- ---
D 57,600 _--_ __12 4,800*
Total hours p.u.: _18 _27
* This shows that either 4,800 units of product P or Q can be obtained by utilizing the available
hours in the four departments.
Decision Making 49
4. Product wise contribution per hour
Product P Product Q
Rs. Rs.
Selling price p.u. (A) 215 320
Total raw material cost p.u.
(Rs. 22 + Rs. 8) 30
(Rs. 28 + Rs. 32) 60
Total wages per unit
(Rs. 36 + Rs. 18 + Rs. 54) 108
(Rs. 54 + Rs. 36 + Rs. 72) 162
Variable overheads p.u. __23 14.30
Total variable cost p.u. (B) 161 236.30
Contribution p.u. [(A-B)] 54 83.70
Labour hours p.u. 18 27
Contribution per labour hour 3 3.10
(54/18 hrs.) (Rs. 83.70/27 hrs.)
(a) Though the contribution per labour hour of product Q is better but there is a constraint viz., the
numbers of workers in each department can neither be interchanged nor newly recruited, hence
due to this following alternatives would arise which may help in deciding about the product mix to
yield maximum profit.
Alternative I: Producing 4,800 units of product Q and utilizing the remaining available hours of
labour for make units of product P.
Alternative II: Producing 4,800 units of product P and utilizing the remaining available hours of
labour for making units of product Q.
Statement of product mix under alternative I
Departments Available hours required Remaining Hours/units of units
Hours for 4,800 units of p hours product Q of product
(a) (b) (c) =(a)-(b) (d) (e) = (c)/(d)
A 72,000 28,800 43,200 9 4,800
B 38,400 14,400 24,000 6 4,000
C 43,200 43,200 --- -- ---
D 57,600 --- 57,600 12 4,800
The above table shows that out of the available hours under alternative II; 4,800 units of product
P and 4,000 units of product Q can be made.
Profit statement under above alternatives
Products First alternative Second alternative
Units Contribution Amount Unit Contribution Amount
p.u. (Rs.) Rs. P.u. (Rs.) Rs.
P 3,200 54.00 1,72,800 4,800 54.00 2,59,200
Q 4,800 83.70 4,01,760 4,000 83.70 3,34,800
Total Contribution: 5,74,560 5,94,000
Less: First cost p.a. 1,44,000 1,44,000
Profit 4,30,560 4,50,000
Second alternative is the most profitable product mix.
(b) Statement of most profitable product if only one product is to be manufactured
Products P Q
Decision Making 50
Contribution per unit (Rs.) : A 54.00 83.70
Maximum possible output (in units): (B) 4,800 4,800
Total contribution : (A) (B) 2,59,200 4,01,760
Product Q is to be preferred.
Statement of most profitable product if only one product is to be manufactured and licence to
import the raw material is only for material worth Rs. 1,80,000
Products P Q
Raw material required p.u. (Rs.) 30 60
Permissible output in units out of imported material
Of Rs. 1,80,000 6,000 3,000
Maximum output possible in the available hours 4,800 4,800
Output possible keeping in view the availability of
Imported material and labour hours (units) 4,800 3,000
Contribution per unit (Rs.) 54 83.70
Total contribution (Rs.) 2,59,200 2,51,100
(4,800 units 54) (3,000 units 87.30)
Product P is to be preferred (i.e. Solution differs) because of import licence restriction, which is
only available for purchasing material worth only Rs. 1,80,000.
___________
Problem 33
The relevant data of X Ltd. for its three products A, B and C are as under:
A B C
Direct material (Rs./units) 260 300 250
Direct labour (Rs./units) 130 270 260
Variable overheads (Rs./unit) 110 230 180
Selling price (Rs./unit) 860 1,040 930
Machine hours required (Per unit) 12 6 3
The estimated fixed overheads at four different levels of 3,600; 6,000; 8,400 and 10,800 machine
hours are Rs. 1,00,000; Rs. 1,50,000; Rs. 2,20,000 and Rs. 3,00,000 respectively. The
maximum demand of A, B and C in a cost period are 500; 300 and 1,800 units respectively.
You are required to find out (i) the most profitable product mix at each level and (ii) the level of
activity where the profit would be maximum.
Solution
Ranking of three products A, B and C
A B C
Selling price (p.u.) (Rs.) 860 1,040 930
Less: Variable cost p.u. (Rs.) _500 _800 _690
Contribution p.u. (Rs.) 360 240 240
Machine hrs. required p.u. 12 6 3
Contribution per machine hour (Rs.) 30 40 80
(Rs. 360/ (Rs. 240/ (Rs. 240/
12 hrs.) 6 hrs.) 3 hrs.)
Ranking III II I
Maximum demand in units 500 300* 1,800
(i) Statement fo the most profitable product mix at each level of machine hours
Machine hours
Product (mix) 3,600 6,000 8,400 10,800
C 1,200 1,800 1,800 1,800
Units units units units
(3,600 hrs/ (5,400 hrs./
Decision Making 51
3 hrs p.u.) 3 hrs p.u.)
B -- 100 300 300
Units units units
(600 hrs/ (1,800 hrs/
6 hrs. p.u.) 6 hrs p.u.)
A -- -- 100 300
Units units
(1,200 hrs/ (3,600 hrs/
12 hrs p.u.) 12 hrs p.u.)

(ii) Statement of level of activity where the profit would be maximum

Products
Level C units contribution B units contribution A units contribution Total Fixed net
Of contribution cost profit
Activity
(Machine
Hours)
Rs. Rs. Rs. Rs. Rs. Rs.
3,600 1,200 2,88,000 --- --- --- --- 2,88,000 1,00,000 1,88,000
(1,200 Rs. 240)
6,000 1,800 4,32,000 100 24,000 --- --- 4,56,000 1,50,000 3,06,000
(1,800 Rs. 240) (100 Rs. 240)
8,400 1,800 4,32,000 300 72,000 100 36,000 5,40,000 2,20,000 3,20,000
(300 Rs. 240) (100 Rs. 360)
10,800 1,800 4,32,000 300 72,000 300 1,08,000 6,12,000 3,00,000 3,12,000
(300 Rs. 360)

Recommendation:
At 8,400 machine hour level of capacity the company would earn maximum profit i.e. Rs.
3,20,000.
Refer to working note
_______________
Price-mix decision:
When a firm can produce two or more products from the same production facilities and the
demand of each product is affected by the change in their prices, the management may have to
choose price mix which will give the maximum profit, particularly when the production capacity is
limited. In such a situation, the firm should compute all the possible combinations and select a
price-mix which yields the maximum profitability.
Problem 34
Dinesh Diaries Ltd. has two processing and bottling plants, Danida and Danima, in adjoining
districts. The comparative cost and revenue data budgeted per month are as below:
Danida Danima
Production (Litres) 1,00,000 75,000
Rs. Rs.
Variable costs:
Bottles 1,00,000 79,000
Closures 90,000 71,500
Crates 14,000 12,500
Milk loss 30,000 47,000
Electricity 14,000 14,000
Fuel 40,000 46,000
Water _10,000 _11,250
2,98,000 2,81,250
Decision Making 52
Fixed costs:
Electricity 13,500 11,000
Salaries & wages 90,000 60,000
Depreciation 50,000 20,000
1,53,500 91,000
Total costs 4,51,500 3,72,250
Sales realization 7,00,000 5,25,000
Profit 2,48,500 1,52,750
Danimas high cost, low margin status draws managements attention. It is also observed
that Danida can increase its production by 50% with the exisiting plant capacity and without
additional manpower.
Two proposals are under consideration:
(1)Cut down Danimas production by 25,000 litres and increase Danidas production by
25,000 litres.
(2)Cut down Danimas production by 50,000 litres and increase Danidas production by
50,000 litres.
For the additional quantity produced in excess of 1,00,000 litres, Danida will incur Re. 0.40
per litre towards group incentive. Transporting the additional output from Danida to Danimas
region for sale will cost Rs. 10,000 in both cases.
(a)Prepare a statement to show the contribution and the profit for Danida, Danima and for the
company as a whole, for each proposal. Comment on the results.
(b)The management is keen that the cut in Danimas production should not result in its
reporting loss, as that would demoralize its employees. If break-even production is to be
retained in Danima and the balance alone is to be transferred to Danida. Show the
contribution and the profit for Danida, Danima and the company as a whole.
Solution
Working Note:
Sales price computation per litre:
Danida Danima
Rs. Rs.
Sales price:
litres
Rs
000 , 00 , 1
000 , 00 , 7 .
7.00
litres
Rs
000 , 75
000 , 25 , 5 .
7.00
Less:
litres
Rs
000 , 00 , 1
000 , 98 , 2 .
2.98
litres
Rs
000 , 75
250 , 81 , 2 .
3.75
_____ _____
Contribution per litre 4.02 3.25
(a) (i) Proposal 1: Statement showing the contribution and the profit for Danida, Danima and for the
company as a whole when Danimas production is cut by 25,000 litres and Danidas
production is increased by 25,000 litres:
Danida Danima Total
Production (Litres) 1,25,000 50,000 1,75,000
Rs. Rs. Rs.
Contribution per litre ___4.02 ___3.25 _______
Total contribution 5,02,000 1,62,500 6,65,000
Decision Making 53
Less: Group incentive payable __10,000 ___---__ __10,000
4,92,500 1,62,500 6,55,000
Less: Fixed costs 1,53,500 __91,000 2,44,500
3,39,000 71,500 4,10,500
Less: Transport cost __10,000 ___---__ __10,000
Profit 3,29,000 __71,500 4,00,500
Budgeted profit 2,48,000 1,52,750 4,01,250
Comments: The proposal, if implemented, will result in a drop, in overall profit by Rs. 750
(Rs. 4,01,250 Rs. 4,00,500).
(a) (ii) Statement showing the contribution and the profit for Danida, Danima and for the company
as whole when Danimas production is cut by 50,000 litres and Danidas production is
increased by 50,000 litres.
Danida Danima Total
Production (Litres) 1,50,000 25,000 1,75,000
Rs. Rs. Rs.
Contribution per litre ____4.02 ____3.25 ________
Total contribution 6,03,000 81,250 6,84,250
Less: Group incentive payable ___20,000 ___--___ ___20,000
5,83,000 81,250 6,64,250
Less: Fixed costs __1,53,500 __91,000 2,44,500
4,29,500 (9,750) 4,19,750
Less: Transport cost ___10,000 __--____ __10,000
Profit 4,19,500 (9,750) 4,09,750
Budgeted profit 2,48,500 1,52750 4,01,250
Comments: The implementation of the proposal will increase profits for the company as a
whole by Rs. 8,500 (i.e., Rs. 4,09,750 Rs. 4,01,250) though Danima will be reporting loss.
(b) (i) contribution per litre for Danima: Rs. 3.25
Total fixed costs of Danima: Rs. 91,000
Break-even production for Danima
= -------------------------------- =
25 . 3 .
000 , 91 .
Rs
Rs
= 28,000 litres
The production that could be transferred from Danima to Danida, retaining break-even
production in Danima, is 47,000 litres (i.e. 75,000 litres 28,000 litres)
(b) (ii) Statement showing the contribution and the profit for Danida, Danima and the company as a
whole when break-even production is retained and the balance is transferred to Danida:
Danida Danima Total
Production (litres) 1,47,000 28,000 1,75,000
Rs. Rs. Rs.
Contribution per litre ____4.02 ____3.25 ____---__
Total contribution 5,90,940 91,000 6,81,940
Less: Group incentive payable __18,800 ___---___ ___18,800
5,72,140 91,000 6,63,140
Less: Fixed costs 1,53,500 __91,000 _2,44,500
4,18,640 ---- 4,18,640
Less: Transport cost ___10,000 ___---___ ___10,000
Profit __4,08,640 ___---____ 4,08,640
Budgeted profit _2,48,500 _1,52,750 4,01,250
Fixed costs
Contribution per litre
Decision Making 54
The overall profit will increase by Rs. 7,390 (i.e. Rs. 4,08,640 Rs. 4,01,250) by transferring
47,000 litres of production to Danida.
Problem 35
Sellaway Ltd. manufactures and markets 2 products A and B, the demand in the market
of which fluctuates with the prices quoted. As a result of the deliberations of its recent
Sales Conference the following data was agreed upon as a working basis :
Product A B
Selling price
per unit Rs. 32 30 28 22 20 18
Expected demand
per month Nos. 900 1,000 1,500 1,600 2,000 3,000
8 labour hours are required to produce product A and 4 labour hours to produce product
B and the maximum capacity of the factory is restricted to 20,000 labour hours per
month.
Rs. Rs.
A B
Direct Material 4 3
Direct Labour 6 5
Variable Overheads __10 __6
20 14
Fixed overheads are Rs. 32,400 per quarter.
You are required to compute the possible combinations and arrival at a proper price mix
for maximum profitability.
Also work out the profitable price-mix in case the space capacity can be fully utilised to
meet additional demand of the products A and B in the ratio 3:2.
Solution
Statement showing possible combinations at different price mixes
Products Contribution Labour Hrs. Reqd.
A B
Rs. Rs. Rs.
32 22 23,600 13,600
32 20 22,800 15,200
32 18 22,800 19,200
30 22 22,800 14,400
30 20 22,000 16,000
30 18 22,000 20,000
28 22 24,800 18,400
28 20 24,000 20,000
28 18 24,000 24,000
The above computations shows that the maximum contribution of Rs. 24,800 is possible
at 18,400 labour hours. Therefore, profitability price mix is : A Rs. 28 and B Rs. 22.
At the above price-mix, the spare capacity is 1,600 labour hours (20,00018,400). If this
spare capacity can be fully utilised to meet additional demand of product A and B in the
ratio 3 : 2, assuming that the additional sales will be effected at the above price mix
then additional production of A will be 150 units and that of B 100 units to absorbed the
spare capacity of 1600 labour hours (1200 + 400). Additional contribution: 150 Rs. 8
+ 100 Rs. 8 = Rs. 2,000.
Decision Making 55
Workings :

Product A Product B
(1) Selling price
Per unit (Rs.) 32 30 28 22 20 18
(2) Expected demand
per month Nos. 900 1,000 1,500 1,600 2,000 3,000
(3) Total labour
Hours required 7,200 8,000 12,000 6,400 8,000 12,000
(4) Variable cost
per unit (Rs.) 20 20 20 14 14 14
(5) Contribution
per unit (Rs.) 12 10 8 8 6 4
(6) Contribution
per hour (Rs.) 1.5 1.25 1 2 1.5 1
(7) Total
Contribution (Rs.) 10,800 10,000 12,000 12,800 12,000 12,000
Question 36
Look Ahead Ltd. wants to fix proper selling prices for their products A and B which they are
newly introducing in the market. Both these products will be manufactured in Department D
which is considered as a Profit Centre.
The estimated data are as under :
A B
Annual Production (Units) 1,00,000 2,00,000
Rs. Rs.
Direct Amterials per unit 15.00 14.00
Direct Labour per unit (Direct Labour Hour Rate Rs.3) 9.00 6.00
The proportion of Overheads other than interest, chargeable to the two products are as under :
Factory Overheads (50% Fixed) 100 per cent of Direct Wages Administration Overheads (100%
Fixed) 10 per cent of Factory Cost. Selling and Distribution Overheads (50% variable) Rs.3 and
RS.4 respectively per unit of products A and B.
The fixed capital investment in the Department is Rs.50 lakhs. The working capital
requirement is equivalent to 6 months stocks of cost of sales of both the products. For this
project a term loan amounting to Rs.40 lakhs has been obtained from Financial Institutions at an
interest rate of 14% p.a. 50 per cent of the working capital needs are met by bank. Borrowing
carrying interest at 18 per cent p.a. The Department is expected to give a return of 20 per cent
on its capital employed.
You are required to :
Fix the selling price of products A and B such that the contribution per direct labour hour is the
same for both the products;
(a) Prepare a statement showing in detail the over-all profit that would be made by the
Department.
Solution
Statement of variable cost, Fixed cost and Total cost
Particulars A B
Variable Fixed Total Variable Fixed Total
Cost cost cost cost cost cost
Rs. Rs. Rs. Rs. Rs. Rs.
Decision Making 56
Direct Materials 15.00 --- 15.00 14.00 --- 14.00
Direct Labour 9.00 -- 9.00 6.00 --- 6.00
Factory overheads 50%
Variable and 50% fixed
(100% of direct wages) _4.50 4.50 9.00 3.00 3.00 6.00
Factory cost 28.50 4.50 33.00 23.00 3.00 26.00
Admn. Overheads 10%
Of Factory cost (100%
Fixed) -- 3.30 3.30 --- 2.60 2.60
S & D overheads 50%
Variable and 50% fixed _1.50 1.50 3.00 2.00 2.00 4.00
Total 30.00 9.30 39.30 25.00 7.60 32.60
A B Total
Annual production units 1,00,000 2,00,000
Variable cost 30 x 1,00,000 = 30,00,000 50,00,000 80,00,000
Fixed cost 9,30,000 15,20,000 24,50,000
Cost of Sales Rs. 39,30,000 65,20,000 1,04,50,000
Capital employed: Rs.
Fixed capital investment in the department 50,00,000
Working capital 6 months stock of cost of sales for both products
Rs. 1,04,50,000 x ------ = 52,25,000
1,02,25,000
Expected return is 20% on capital employed = ------ x 1,02,25,000
Rs.
= 20,45,000
Add: cost of sales 1,04,50,000
Sales value 1,24,95,000
Less: Variable cost 80,00,000
Contribution 44,95,000
Total Direct Labour Hours:
A ---- = 3 hours x 1,00,000 = 3,00,000
B ----- = 2 hours x 2,00,000 = 4,00,000
7,00,000
Contribution per Direct Labour Hour = ------------------ = Rs. 6,4214285
Fixation of selling price:
A B
Rs. Rs.
Variable cost per unit 30.00 25.00
Contribution per unit
6.4214285 x 3 = 19.27 12.84
Selling price per unit 49.27 37.84
9
3
6
3
44,95,000
7,00,000
6
12
20
100
Decision Making 57

(b) Statement of over al l profitability of the Department D
Particulars A B Total
Production & Sales Units 1,00,000 2,00,000
Rs. Rs. Rs.
Selling price per unit 49.27 37.84
Sales value 49,27,000 75,68,0001,24,95,000
Variable cost 30,00,000 50,00,000 80,00,000
Contribution 19,27,000 25,68,000 44,95,000
Less: Fixed overheads 24,50,000
Operating profit (i.e., 20% return on capital employed) 20,45,000
Less: Interest on term loan at 14% on Rs. 40 lakhs 5,60,00
Interest on working capital at 18% on 50% of working
Capital 18% x 50% x 52,25,000 = 4,70,250
10,30,250
Over all profitability 10,14,750
Own or Lease:
In recent years, leasing has become a popular source of financing plants and machinery in India.
Due to this, a large number of companies have entered into leasing business, from the lessees
point of view, leasing has the attraction of eliminating immediate cash outflow, and the lease
rentals can be deducted for computing the total income under the Income tax Act. As against this,
buying has the advantages of depreciation allowance (including additional depreciation) and
interest on borrowed capital being tax deductible. Thus, an evaluation of the two alternatives may
be made in order to take a decision.
Problem 37
Fitwell Ltd., a large manufacturing company has three factories namely factory A, factory B and
factory C. All the three factories produce the same product which is sold at Rs. 375 per unit. The
factory-wise estimates of operating results for 1986 are as under:
(Rs. Lakhs)
A B C Total
Sales 300 1,200 600 2,100

Costs:
Raw Materials 75 350 145 570
Direct labour 75 280 140 495
Factory OverheadsVariable 20 110 55 185
Fixed 40 120 60 220
Selling and Distribution
OverheadsVariable 23 70 40 133
Fixed 15 50 30 95
Administration Overheads 20 90 40 150
Head Office Expenses 12 50 30 92

Total 280 1,120 540 1,940

Profit 20 80 60 160

Decision Making 58
With the above estimates were under finalisation, the companys legal department advised that
the lease of factory A was due to expire on 31
st
December, 1985 and that it could be renewed
by enhancing the least rent by Rs. 12 lakhs per annum. Since this enhancement will have a
heavy impact on the profitability of the company, the management is constrained to examine the
proposals which are as under:
(i) Renew the lease and bear the impact
(ii) Close down factory A, sell off the plant, machinery and stocks and liquidate all liabilities,
including the staff and workers retrenchment compensation from the sale proceeds which
are sufficient for this purpose.
(iii) In order however to maintain the customer relations the total planned output of the factory
A will be transferred to EITHER factory B OR factory C. Plant capacity is available at both
the factories to take over the manufacture. The additional cost involved in the manufacture
of the extra output so transferred in factories B and C are estimated as under:
Factory Factory
B C
(a) Additional fixed overheads due to
increase capacity utilisation (Per
Annum)
Rs. 50 lakhs
Rs. 40 lakhs
(b) Additional freight, selling and other
overheads to produce and distribute
the output to the present customer of
factory A
Rs. 25 per unit
Rs. 35 per unit
You are required to prepare comparative statements of profitability in the aforesaid alternative
courses of action and give your recommendation.
Solution
(i) Fitwell Limited
Impact on profit of continuance of production by renewing the lease :
(Rs. lakhs)
FACTORIES
A B C Total
Sales (A) 300 1,200 600 2,100

Costs:
Raw materials 75 350 145 570
Direct labour 75 280 140 495
Factory overheads (Variable) 20 110 55 185
Selling & distribution overheads
(Variable) 23 70 40 133

Total variable costs (B) 193 810 380 1,383

Contribution (C) (AB) 107 390 220 717
Decision Making 59

Factory overheads (Fixed) 40 120 60 220
Selling & distribution overheads
(Fixed) 15 50 30 95
Administration overheads 20 90 40 150
Head office expenses 12 50 30 92
Additional lease rent 12 12

Total fixed overheads (D) 99 310 160 569

Profit (CD) 8 80 60 148

The above statement shows that transfer of production of factory A to factory C yields higher
profit, i.e., Rs. 182 lakhs, hence this course may be adopted.
(ii) COMPARATIVE STATEMENT OF PROFITABILITY
When production of factory A is
transferred to Factory B
When production of factory A is
transferred to Factory C
B C Total B C Total
Sales
Variable costs
Contribution
Fixed Costs
Profit
1,500.00 600 2,100.00
1,032.50 380 1,412.50
467.50 220 687.50
360.00 160 520.00

107.50 60 167.50

1,200 900 2,100
810 598 1,408

390 302 692
310 200 510

80 102 182

The above statement shows that as a result of renewal of lease of factory A the total profit gets
reduced from Rs. 160 lakhs to Rs. 148 lakhs. However, factory A is still contributing towards
meeting the head office expenses. Hence, it may not be advisable to discontinue the lease.
(ii) Workings : (*)
(*)This solution may also be made with the assumption that head office expenses
attributable to factory A will be charged to the factory to which its production has been
transferred.
(a) FIXED AND VARIABLE COSTS WHEN THE PRODUCTION OF FACTORY A IS
TRANSFERRED TO FACTORY B
(Rs. lakhs)
Sales Variable Costs Fixed Costs
B 1,200 810.0 310
A 300 202.5 (810/1,200 300) ____
Additional Costs 20.0 (80,000* Rs. 25) 50

Total 1500 1,032.5 360

* Rs. 3,000 Rs. 375 = 80,000 units.

Decision Making 60
(b) FIXED & VARIABLE COSTS WHEN THE PRODUCTION OF FACTORY A IS
TRASNFERRED TO FACTORY C (Rs. lakhs)
Sales Variable Costs Fixed Costs
C 600 380 160
A 300 190 (380/600 300)
Additional costs 28 (80,000 Rs. 35) 40

Total 900 598 200
_____________
Problem 38
The operations Manager of Flexishop Enterprises is considering the possibility of leasing
equipment for a new flexible manufacturing system (FMS) to replace existing equipment. The
FMS lease will increase annual fixed costs by Rs. 9,00,000 per year and reduce variable costs
by Rs. 800 per job.
The manager believes that the annual no. of jobs processed by the firm will be 900, 1,200 or
1,500. The probabilities of these events occurring are:
Annual no. of jobs Probability
900 0.25
1,200 0.45
1,500 0.30
1.00
Required:
Should the company lease the FMS? Support your conclusions with appropriate calculations.
Solution
Statement of conditional savings of two action
Job Conditional savings (Loss)
900 1,200 1,500
Jobs (x1) Jobs (x2) Jobs (x3)
Actions: Rs. Rs. Rs.
Lease FMS (a1) (1,80,000) 60,000 3,00,000
(Refer to working note)
Do not lease (a2) 0 0 0
(Continuing with existing equipment)
The expected savings of two actions are:
3
E (a1) = p (xj) conditional savings (loss) for each job.
J = 1
E (a1) = 0.25 (1,80,000) + (0.45 60,000) + (0.3 3,00,000)
= (Rs. 45,000) + Rs. 27,000 + Rs. 90,000 = Rs. 72,000
E (a2) = 0
Conclusion: The firm will maximise its expected monetary value by leasing the FMS equipment.
Working note:
Condition saving (loss) for each job:
= [(Reduction in variable cost) Annual no. of jobs increase of annual fixed costs]
Decision Making 61
Conditional savings (loss) for 900 jobs:
= [Rs. 800 900 jobs-Rs. 9,00,000] = Rs. (1,80,000)
Conditional savings (loss) for 1,200 jobs:
= [Rs. 800 1,200 jobs-Rs. 9,00,000] = Rs. 60,000
Conditional savings (loss) for 1,500 jobs:
= [Rs. 800 1,500 jobs Rs. 9,00,000] = Rs. 3,00,000
-----------
Sell or Scrap, Retain or Replace & Repair or Renovate:
All plants and equipments have a life span during which they provide service or work with
optimum efficiency. The span of their life can be prolonged by retaining such plants and carrying
out necessary repairs or renovation. Despite proper maintenance of highest degree, a stage
ultimately comes when it becomes no longer economical to use such plants and equipments. It
means that they have exhausted their useful life. At this stage the options available to the
concern are to replace the old plant with a new one and sell the old plant at a price or sell it as a
scrap.
The replacement of old plant and machinery is an important decision. Before making a decision in
this regard, it is necessary to examine all available possibilities an mentioned above. For taking a
decision in favour of the aforementioned possibilities, it is necessary to consider the following cot
and non-cost factors.
Cost factors
1. Comparison of operating costs of the existing plant (if it has to continue in the future period)
with the operating costs of the alternative plant (new plant with which the existing plant will be
replaced).
2. Figures of comparative profitability, return on capital employed and interest on capital.
3. Assessment of opportunity costs to determine whether the funds proposed to be diverted for
procurement of the new asset in replacement could be more gainfully deployed elsewhere.
4. Effect of disposal of the existing plant. The disposal value of the existing plant should be
taken so as to reduce the procurement cost of replacement plant and in order to determine
the total investment to be made for the replacement.
5. Additional capital expenditure of an obligatory nature to be incurred, if any, on related or
allied projects such as those for welfare.
6. Effect on tax liability due to profit or loss on the sale of plant/machinery to be replaced.
Non-cost factors:
1. If the product is likely to become obsolete or go out of fashion in the near future, it will not be
worthwhile to go in for plant replacement.
2. Whether the market will be capable of absorbing the product manufactured by the new plant
in its entirety at the anticipated price.
3. Whether there are any constraints on the resources required for the new plant.
4. Whether the new plant is likely to create any bottleneck or imbalances in subsequent
operations or process and if so, whether these can be removed.
Decision Making 62
5. The possibility of any substitute product coming up which may make the replaced plant
redundant.
6. Likely effects of any change in the policy of the Govt. with regard to import of raw materials,
export of products, levy of duties etc.
Methods used for this decision making
There are three methods used for arriving at a decision as to whether a machine should be
retained or replaced. The methods which can be used are as follows:
(i) Marginal costing approach
(ii) Differential cost approach
(iii) Discounted cash flow method.
Problem 39
A manufacturing unit engaged in the production of automobile parts has a ten year old plant
which has been depreciated according to the straight line method. The estimated total life of the
plant is 20 years. The original cost including, installation was Rs. 24 lakhs and the residual value
after 20 years was estimated to be Rs. 4 lakhs. The output of the factory per minute is 200 units.
It is proposed to install a new plant with a purchase price of Rs. 38 lakhs with a part exchange
provision of Rs. 8 lakhs in respect of the existing plant. The new plant has an estimated life of 15
years and a residual value of Rs. 4 lakhs. The output of the new plant is 400 units per minute
and its installation cost is 2 lakhs.
The annual costs of the two plants are to be taken as follows:
Existing New
Running hours p.a. 2,500 2,500
Costs Rs. Rs.
Wages 1,00,000 1,40,000
Sundry indirect materials 4,80,000 6,00,000
Repairs and maintenance 80,000 1,00,000
Power and steam 2,40,000 2,80,000
Proportion of general fixed assets 60,000 80,000
Will it be advantageous to buy the new plant of not? Substantiate your answer with the help of
comparative unit cost with both the plants. Assume interest for capital as 10%.
Make other relevant assumptions.
Note: 10% interest table:
20 years 15 years
Present value of Re. 1 0.1486 0.2394
Annuity of Re. 1 (capital recovery factor with 10% interest) 0.1175 0.1315
Solution
It will be advantageous to purchase the new plant since it will reduce the cost per 1,000 units of
production to Rs. 28.55 from Rs. 41.17, which is the cost if the existing plant is retained. (This
computation is made ignoring the, immediate cash flow of Rs. 8 lakhs accruing from the part
exchange of the old plant). Assuming the cost of capital at 10% the comparative costs under the
two plants are shown in the following statement.
Decision Making 63
Statement showing comparative costs under the two plants
Existing plant new plant
Capital cost including installation (Rs.) 24,00,000 40,00,000
Running hours p.a. 2,500 2,500
Annual output (units) 3 crores 6 crores
Rs. Rs.
Operating costs:
Repairs & maintenance 80,000 1,00,000
Indirect materials 4,80,000 6,00,000
Power & steam 2,40,000 2,80,000
Direct wages 1,00,000 1,40,000
9,00,000 11,20,000
General fixed costs 60,000 80,000
Annual capital cost
[Includes depreciation and interest equivalent at
10% (See note)] 2,75,000 5,13,000
12,35,000 17,13,000
cost per 1,000 units 41.17 28.55
Note: Regarding depreciation cost, an appropriate method would be to determine the annual cost
of capital equipment on the, basis of the discounted cash flow method. This method would
involve the following calculations:
Existing Plant New plant
(a) Original cost Rs. 24 lakhs Rs. 40 lakhs
(b) Useful life 20 years 15 years
(c) Salvage value at the end of use full life Rs. 4 lakhs Rs. 4 lakhs
(d) Rate of discount 10% 10%
(e) Discount factor 0.1486 0.2395
(f) present value of the salvage value (c e) 0.59 0.96
(g) Net present value of plant (a-f) (Rs. In lakhs) 23.41 39.04
(h) Capital recovery factor 0.1175 0.1315
(i) Annual cost for the next year (g h) Rs. 2.75 lakhs Rs. 5.13 lakhs
_____
Problem 40
A company proposes to replace its old and obsolete machine. Two models of machines available
are as under:
(i) Automatic machine involving an initial capital outlay of Rs. 5,000. The annual operating cost
of this model is Rs. 1,50,000. Salvage value at the end of its life of 5 years is Rs. 20,000.
(ii) Semi automatic machine involving an initial capital cost of 3,00,000. The annual operating
cost is Rs. 2,10,000. Salvage value at the end of its life of 5 years is Rs. 10,000.
The companys cost of capital is 14%. Which alternative is to be preferred? Ignore tax.
Solution
(a) Evaluation of replacement proposal of old and obsolete machine
(i) Automatic Machine:
Rs. Rs.
Initial capacity outlay 5,00,000
Annual operating cost 1,50,000
Less: depreciation

,
`

.
|
years
Rs Rs
5
000 , 20 . 000 , 00 , 5 .
__96,000
Decision Making 64
Annual cash operating cost __54,000
Present value of total cash operating
Costs in 5 years
(Rs. 54,000 3.43) at 14% _1,85,220
Less: Present value of salvage at 14%
(Rs. 20,000 0.52) ___10,400
Total cost _6,74,820
(ii) Semi-Automatic machine:
Initial capacity outlay 3,00,000
Annual operating cost 2,10,000
Less; Depreciation

,
`

.
|
years
Rs Rs
5
000 , 10 . 000 , 00 , 3 .
___58,000
Annual cash operating cost __1,52,000
Present value of total cash operating costs
In 5 years at 14% (Rs. 1,52,000 3.43) _5,21,360
8,21,360
Less: Present value of salvage at 14%
(Rs. 10,000 0.52) _____5,200
Total cost _8,16,160
Alternative (i) above i.e., replacement with automatic machine is to be preferred since the total
cost on it is less by Rs. 1,41,340 (Rs. 8,16,160 Rs. 6,74,820)
Note: Depreciation has been computed according to straight-line method.
___________
Problem 41
A company proposes to install a machine for the manufacture of a component, which at present
is being purchased at Rs. 24 each. There are two alternatives, namely (a) installation of an
automatic machine and (b) installation of a semi-automatic machine. The details of the two
machines are as under:
Automatic Semi-Automatic
Machine Machine
Initial cost of the machine (Rs.) 9,00,000 6,00,000
Life 10 years 10 years
Fixed overheads other than depreciation
on machines (per annum) (Rs.) 1,62,000 84,000
Variable expenses of the component (Rs.) 12 15
The company charges depreciation on straight-line method. Scrap value of the machine at the
end of life is nil.
The demand of the components at present is 20,000 units per annum. This demand is expected
to increase to 40,000 units.
Required:
a) For each of the two volumes of output namely 20,000 and 40,000 units, state with
supporting calculation whether the components should be purchased or manufactured by
installation of machine. If your decision is in favour of installation of machine, which model
will you advise?
b) At what volume of output should the company change over from purchase of components to
manufacture by installation of (i) semi-automatic machine and (ii) automatic machine.
Decision Making 65
c) At what volume of manufacture of the components will the company switch over from
installation of one type of machine to the other?
Solution
(a) STATEMENT SHOWING PER UNIT COST UNDER DIFFERENT ALTERNATIVES
Production
Output: 20,000 units output: 40,000 units

Automatic Semi-Automatic Automatic Semi-Automatic
Machine Machine Machine Machine
Rs. Rs. Rs. Rs.
Variable Cost 12.00 15.00 12.00 15.00
Fixed overheads other
than depreciation
Rs. 1,62,000 20,000 8.10
Rs. 1,62,000 40,000 4.05
Rs. 84,000 20,000 4.20
Rs. 84,000 40,000 2.10
Depreciation:
Rs. 9,00,000 1
4.50
10 20,000
Rs. 9,00,000 1
2.25
10 40,000
Rs. 6,00,000 1
3.00
10 20,000
Rs. 6,00,000 1
1.50
10 40,000

Total cost of manufacture 24.60 22.20 18.30 18.60
Cost of buying per unit 24.00 24.00 24.00 24.00
At the volume of 20,000 units, cost of manufacture is less by semi automatic machine. Hence,
semi automatic machine should be installed. At the volume of 40,000 units, cost of
manufacture is less under automatic machine. Hence, installation of automatic machine is
desirable at that activity level.
(b) Change over from purchase to manufacture
Automatic Semi-Automatic
Machine Machine
Rs. Rs.
Purchase price of component 24.00 24.00
Variable cost of manufacture 12.00 15.00
Saving 12.00 9.00
No. of units at which changeover is to be effected ---------------------
Rs. 2,52,000 Rs. 1,41,000

12 9
Fixed cost
Saving per unit
Decision Making 66
= 21000 units = 16000 units
Working Note:
Total fixed cost per annum:
Rs. 9,00,000
+ Rs. 1,62,000 = Rs. 2,52,000
10
Rs. 6,00,000
+ Rs. 84,000 = Rs. 1,44,000
10
(c) Statement showing activity level for Switch-over from one type of machine to the other
Automatic Semi-Automatic Difference
Machine Machine
Rs. Rs. Rs.
Differential variable costs 12 15 3
Differential fixed costs 2,52,000 1,44,000 1,08,000
No. of unit at which switch
over is to effected Rs. 1,08,000
= 36,000 units
3

Problem 42
Navyog Enterprises is considering the introduction of a new product. Generally, the companys
products have a life of about five years, after which they are usually dropped from the range of
products the company sells.
The new product envisages the purchase of new machinery cost Rs. 4,00,000 including freight
and installation charges. The useful life of the equipment is five years, with an estimated salvage
value of Rs. 1,57,500 at the end of that time. The machine will be depreciation for tax purposes
by reducing balance method at a rate of 15% on the book value.
The new product will be produced in a factory, which is already owned by the company. The
company built the factory some years ago at Rs. 1,50,000. The book value on the written down
value basis is zero.
Today the factory has a resale value of Rs. 3,50,000 which should remain fairly stable over the
next five years. The factory is currently being rented to another company under a lease
agreement, which has five years to run, and which provides for an annual rental of Rs. 5,000.
Under the lease agreement, if the lesser wishes to cancel the lease, he can do so by paying the
lessee compensation equal to one years rental payment. This amount is not deductible for
income tax purposes.
Additions to current assets will require Rs. 22,500 at the commencement of the proposal, which,
it is assumed, is fully recoverable at the end of year 5. The company will have to spend Rs.
50,000 in year 1 towards research.
The net cash inflows from operations before depreciation and income tax are:
Year Rs.
1 2,00,000
2 2,50,000
3 3,25,000
4 3,00,000
5 1,50,000
Decision Making 67
It may be assumed that all cash flows are received or paid at the end of each year and that
income taxes are paid in the year in which the inflow occurred.
The companys tax rate may be assumed to be 50% and the companys required return after tax
is 10%.
Solution
Workings:
Rs.
(1) Initial cash outflows:
Cost of new machinery 4,00,000
Cancellation of lease 5,000
Working capital __22,500
Total cash outflow 4,27,500
(2) Market research outlay:
Outlay 50,000
Less: Tax saving at 50% __25,000
Net outlay to be recognised in year 1 __25,000
(3) Opportunity cost, i.e.,
Rent of factory foregone on 5,000
Cancellation of lease rent __2,500
__2,500
Net cash outflow of Rs. 2,500 is to be recognised each year for years 1 to 5.
(4) Deprecation @ 15% by the reducing balance method:
Year Book value Depreciation
Rs. Rs.
1 4,00,000 60,000
2 3,40,000 51,000
3 2,89,000 43,350
4 2,45,650 36,848
5 2,08,802 31,320
(5) Computation of net cash inflows from operations:
Cash inflows = (operating cash inflows before and tax depreciation) (1- Tax rate) +
Depreciation.
Year
1 (Rs. 2,00,000 Rs. 60,000) (1-0.5) + Rs. 60,000 = Rs. 1,30,000
2 (Rs. 2,50,000 Rs. 51,000) (1-0.5) + Rs. 51,000 = Rs. 1,50,500
3 (Rs. 3,25,000 Rs, 43,350) (1 0.50) + Rs. 43,350 = Rs. 1,84,175
4 (Rs. 3,00,000 Rs. 36,848) (1 0.50) + Rs. 36,848 = Rs. 1,68,424
5 (Rs. 1,50,000 Rs. 31,320) (1-0.50) + Rs. 31,320 = Rs. 90,660
(6) Sales of machinery:
Rs.
Book value 1,77,482
(Rs. 2,08,802 Rs. 31,320)
Less: sales value 1,57,500
Loss on the sale of machinery 19,982
Tax saving at 50% 9,991
Decision Making 68
Therefore inflow in the 5
th
year on this account to be recognised:
Rs. 1,57,500 + Rs. 9,991 = Rs. 1,67,491
(7) Amount of working capital of Rs. 22,500 will be shown as inflow in year 5.
Computation of net present value to evaluate to proposal
Year ____ Cash flows______ Net cash Present present
Cash out Cash in flows Value factor value
At 10%
1 2 3 4 = (3) (2) 5 6 = (4) (5)
Rs. Rs. Rs. Rs.
0 4,27,500 ---- (4,27,500) 1,000 (4,27,500)
1 25,000 ---- --- --- ---
2,500 1,30,000 1,02,500 0.909 93,173
2 2,500 1,50,500 1,48,000 0.826 1,22,248
3 2,500 1,84,175 1,81,675 0.751 1,36,438
4 2,500 1,68,424 1,65,924 0.683 1,13,326
5 2,500 90,660
1,67,491 2,78,151 0.621 1,72,732
22,500
Net Present value
Note: Figures in brackets indicate cash outflows:
Recommendation: Since the net present (Rs. 2,10417) of the above proposal is positive, the
company should introduce the new product.
________
Sell or further process:
Sell or process further refers to a decision making situation where an executive has to decide
either to sell a component/product/raw material as it is or alternatively process it further by
incurring additional expenses. For instance, sometime, a redundant material lying in stores for a
long time may be sold as scrap at a small value or may be thrown away as waste. This material
may, however, be converted into a product of higher saleable value by carrying out some further
operations or processes. On further processing the component/Product/raw material may not only
be improved or reconditioned but will mostly fetch a higher sale value as well. Here if the
differential sales value is more than the future processing cost, then it is beneficial to process the
product further otherwise sell it without further processing. Such type of decision making
problems usually arise in the case of joint products.
Problem 43
Chem & Co. Ltd. produces two joint products J and K in department A from a basics raw
materials. The input output ratio of Department A is 100 : 90. product J which becomes the
input of department B can be further processed in Department B to make one of the most
popular industrial product N. The input output ratio of Department B is 100: 95. Alternatively
product J can also be sold at the split off stage.
The selling prices are
Product Rs. Kg.
J 29.40
K 26.00
N 31.50
The departmental expenses, production data and selling expenses envisaged in the budget for
1986 as under:
Decision Making 69
(a) Departmental expenses:
A B
Lakhs Lakhs
Rs. Rs.
Raw Materials Rs. 16 per kg.
Direct Materials 10.00 3.00
Direct wages 15.00 5.00
Variable overheads 20.00 7.00
Fixed overheads 25.00 10.00
(b) Production data
Product Kg.
N 4,75,000
K 8,50,000
(c) Selling expenses:
Product Rs.
J 1,00,000
K 2,00,000
N 2,00,000
You are required to:
(i) Prepare a statement showing the apportionment of Joint costs between products J and K.
(ii) Advise whether the company should process j further into product N or not. Show working.
(iii) Present a statement of profitability based on your decision.

Solution
Production of J is not given in the question. Hence it is ascertained as follows:
Output of N = 4,75,000 kg.
Input to N i.e. output of J
= 4,75,000 x
90
100
= 5,00,000 kgs. Of product J.
8,50,000 kgs of product K.
Total output in
Dept. A: 13,50,000 kgs.
Input to A i.e. consumption of raw materials
13,50,000 x ------ = 15,00,000 kg.
Joint Costs of Dept. A
Rs. In Lakhs
Raw Materials 15,00,000 kgs. At Rs. 16 = 240
Direct Materials 10
Direct Wages 15
Variable overheads 20
Fixed overheads 25
Joint costs: 310
(i) Statement of apportionment of joint costs between J & K (Rs. In Lakhs)
J K Total
100
90
Decision Making 70
Production (kgs.) 5,00,000 8,50,000 ---
Selling price (Rs.) 29.40 26.00 ---
Sales value (Rs.) 1,47,00,000 2,21,00,000 3,68,00,000
Less: Selling expenses (Rs.) __1,00,000 ___2,00,000 ___3,00,000
Market value at split off stage (Rs.) 1,46,00,000 2,19,00,000 3,65,00,000
% 40 60 100
Joint costs apportioned in the ratio
Of 40:60 (Rs.) 1,24,00,000 1,86,00,000 3,10,00,000
Statement of profitability of j & K are sold at split off point (Rs. In Lakhs)

J K Total
Production & Sales (kgs.) 5 8.5 ---
Selling price per kg. (Rs.) 29.40 26.00 ---
Sales value (Rs.) : (A) __147 __221 __368
Joint costs apportioned 124 186 310
Add: Selling exp. ___1 2 3
Total cost 125 188 313
Sales value 147 221 368
Profit 22 33 55
Less: under absorption of fixed
Overheads of Dept. B __10
Net profit 45

(ii) Statement of profitability, if J is converted into N & K is sold at split off point (Rs. In
Lakhs)

N
Joint cost of i.e., input cost of J 124.00
Joint cost of K
Dept. B:
Direct Materials 3.00
Direct Wages 5.00
Variable overheads 7.00
Fixed overheads 10.00
Selling expenses ___2.00
Total costs 151.00
Sales value of N: 4.75 kg. Rs. 31.50 149.625
Profit (Loss) (1.375)
In case J is not processed further, the profitability of J would be:
Rs.
Joint costs 124
Add: selling expenses __1
Total costs 125
Sales value of J: 5,00,000 kg. Rs. 29.40 147
Profit 22
Less: under recovery of fixed
Overhead of Deptt. B 10*
Net profit 12
If J is converted into N, it will incur a loss of Rs. 1,37,500. Hence it is not advisable to process J
further into Product N. It is profitable to sell the product J at split off point.
Decision Making 71
(iii) Profitability Statement based on the above decisions.

J K Total
Production & Sales (kgs.) 5,00,000 8,50,000 ---
Selling price (Rs.) 29.40 26.00 ---
Sales value (Rs.) (A) 1,47,00,000 2,21,00,000 3,68,00,000
Joint cost (Rs.) 1,24,00,000 1,86,00,000 3,10,00,000
Add: Selling expenses (Rs.) __1,00,000 ___2,00,000 ___3,00,000
Total cost (Rs.) B 1,25,00,000 1,88,00,000 3,13,00,000
Profit Rs. (A-B) 22,00,000 33,00,000 55,00,000
Under recovery of fixed exp. of
Dept. B (Rs.) 10,00,0000
Net profit Rs. 45,00,000
Change Vs. Status QUO:
While studying the problems of asset replacement, we saw that the capital loss (written down
value less sales value) at the time of making a decision should be added to the cost by prorating
over the life of the new assets. This course is followed particularly when competition is not serve.
If, however, competition is serve, the firm which produces at high cost will find it difficult to survive
and hence the capital loss is not added to cost. In such cases, a change in favour of
sophisticated machinery is preferable to compete in the market provided the unit cost of
production is comparatively less in the sophisticated plant.
Problem 44
Old new
Machine machine
Labour cost p.a. (Rs.) 4,800 7,200
Operating expenses p.a. (Rs.) 1,200 2,300
Capital cost (Rs.) 24,000 40,000
Estimated production units p.a. 2,400 7,200
Life in years 10 10
Interest in 15% on capital cost
Solution
Existing New
Machine Machine
Rs. Rs.
Labour cost 4,800 7,200
Operating expenses 1,200 2,300
Depreciation 2,400 4,000
Interest @ 15% 1,800 6,000
Total cost p.a. 10,200 19,500
Units p.a. 2,400 7,200
Cost per unit 4.25 2.71
Assuming that the existing plant has served 5 years, and taking interest on its written down value
the replacement of the existing machine by the new machine is preferable.
_________
Decision Making 72
Problem 45
The following is the summary of cost data of a firm.
Sales 10,000 units Variable cost Rs. 1.60
Selling price Rs. 2.10 Fixed expenses Rs. 3,000
There are two proposals before the firm.
(a) improve quality and sell an additional quantity of 5,000 units at the same price. Quality
improvement increases the variable cost by Rs. 0.10 per unit.
(b) Reduce selling price by Rs. 0.12 per unit and sell and additional quantity of
5,000 units.
In both the cases, the manufacture of additional quality will entail an increases in fixed expenses of Rs.
1,000.
Solution
Present case______ Proposed case____
(a) (b)
Expected sales (units) 10,000 15,000 15,000
Selling price (Rs.) 2.10 2.10 1.98
Variable cost (Rs.) 1.60 1.70 1.60
Contribution (Rs.) 0.50 0.40 0.38
Total contribution (Rs.): (A) 5,000 6,000 5,700
Fixed expenses (Rs.) (B) 3,000 4,000 4,000
Profit (Rs.) : (A B) 2,000 2,000 1,700
The analysis of the above data indicates that status quo is preferred although the possibility of a
future price rise may justify change in favour of proposal (a).
_________
Product Decisions:
Product Development decision: Product development embraces new development, major
modification of existing products, manufacture of products which are similar to those of
competitors, product line acquisition, etc. all of which involve assimilation of something new into
the product mix. There are six stages of innovation process involved in the product development.
There are:
a) Idea generation
b) Screening
c) Business analyzing
d) Developing the product in a concrete form,
e) Test marketing, and
f) Commercialization
(a) Idea generation: A large number of ideas are generated in order to ensure finding a few good
ones. Ideas are continually being generated through customers, technology, competitors,
firms scientist and salesmen. Ideas also emanate from conferences and discussion at
meetings.
(b) Screening: The purpose of screening is to eliminate from further consideration those product
ideas which are not in conformity with the companys objectives or resources. The objective
may be maximum profit, sales stability, sales growth or company image. If the product idea is
compatible with these objectives, it will be examined in the light of availability of resources,
viz., capital, know how, production facilities to be used for the manufacture, etc. product
ideas that pass these tests will move on to the next stage.
Decision Making 73
(c) Business analysis: The objective of this analysis is to estimate the future sales, profit and rate
of return for the proposed new product and also to determine whether these are in conformity
with the objective of the company. If they conform to the objectives, the project will be
continued. There are a number of methods for carrying out business analysis.
Methods of business analysis
Some of the methods used are explained below:
1. Break-even model: Under this method, the firm estimates its break-even volume and
proceeds to consider whether the estimated sales are likely to exceed this volume or not. The
break-even volume is the sales volume in quantity which is necessary to cover all costs
involved in developing, producing and also the opportunity cost of capital. The break-even
model, however, has certain shortcomings. They are:
(i) The sales of new product will register a gradual growth but break-even volume will only
take into account the average output for the year.
(ii) The cost and revenues will increase with the growth in sales volume. In such
circumstances, payback period will give a better idea about the profitability of the new
product. The shorter the payback period the greater will be managements confidence in
the new product. Payback period is essentially a measure of time that it will take to
recoup the money invested in the form of cash from operations. It is handy device (a)
where precision in estimates of profitability is not crucial and a preliminary screening of a
number of proposals is necessary and (b) where the contemplated project is very risky.
(iii) Another problem with break-even analysis is that several costs in the development stage
such as start up costs, opportunity costs, etc., cannot be classified as fixed and variable.
Thus break-even analysis is too simple to guide decision making in the costly and vital
area of product development.
2. Discounted cash flow method: In the case of new products, revenues and costs change
during the products life cycle and hence the discounted cash flow method is used widely to
evaluate the investment in capital projects.
3. Marketing mix method: Since pricing, sales promotion and distribution will affect sales and
costs, these factors can be introduced in a break-even model as under to decide about the
break-even volume of sales:
B = {(F+A+D) (P-C)}
Where,
B = Break-even sales volume in units
F = Non-marketing fixed costs
A = Advertisement and promotional expenses
D = Distribution costs
P = Selling price per unit
C = Variable cost per unit
4. Bayesian decision method: This approach allows a flexible and detailed model to be built
using probability to take care of uncertainty involved in the new product or projects. Thus in
new projects, the firm is not certain about the profit potentiality, pricing strategies, best size of
the plant etc. To illustrate, taking a company having a number of alternatives, the problem
can be analysed as under:
Decision Making 74
1. There are three alternative pricing policies; skimming price, penetration price and
intermediate price.
2. there are two plant sizes, viz. medium size or large size.
3. There are three forecasts of sales and demand, viz., optimistic, most likely and
pessimistic. Taking these data, 18 expected present values can be calculated in the
form of decision tree and out of which the project which yields the highest expected
present value can be selected.

Price policy Size of Forecast of Probability Present Expected
Plant demand value of present
Cash flow value
1. Skimming Medium Optimistic 0.3 30.4
Most likely 0.5 14.2 10.44
Pessimistic 0.2 -28.9
Large Optimistic 0.3 37.6
Most likely 0.5 13.5 12.03
Pessimistic 0.2 -30.0
2. Intermediate Medium Optimistic 0.3 27.3
Most likely 0.5 10.7 8.58
Pessimistic 0.2 -24.8
Large Optimistic 0.3 34.0
Most likely 0.5 10.5 10.25
Pessimistic 0.2 -26.0
3. Penetrate Medium Optimistic 0.3 21.7
Most likely 0.5 08.7 1.52
Pessimistic 0.2 -46.7
Large Optimistic 0.3 26.4
Most likely 0.5 10.0 4.88
Pessimistic 0.2 -40.2
It may be seen from the above table that the expected present value of the big plant using
skimming price is the highest, namely Rs. 12.03 lakhs and hence this project is acceptable.
Problem 46
GG Ltd. manufactures and sells an equipment called water purifier. The cost data for each batch
of ten numbers of water purifier is as follows:
Components A B C D E
Machine hours 20 28 24 --- ---
Labour hours -- -- -- 4 2
Rs. Rs. Rs. Rs. Rs.
Variable costs 64 108 116 24 8
Fixed costs as
Apportioned 36 52 64 26 22
Assembly costs (all variable) Rs. 50 per batch.
Selling price Rs. 800 per batch.
Decision Making 75
Maximum available machine capacity for making components A, B and C is 10,800 hours
and it cannot be increased further. Labour is available for making components D and E and
for assembling the product.
Estimated increase in demand next year is 50% and fixed costs is general may increase by
Rs. 10,000.
In order to release production capacity to meet increased market demand, the company
decided to purchases one of the machine made components.
Quote Ltd. is the only supplier of components A, B and C. Because of incomplete records, it
is unable to quote single figure prices. Its quotation is as follows:
Component Pessimistic Probability Most Likely probability optimistic probability
View view View
Rs. Rs. Rs.
A 120 0.25 110 0.5 80 0.25
B 200 0.25 130 0.5 140 0.25
C 160 0.25 140 0.5 120 0.25
It is agreed between the companies that the price of each of the components will be
determined on an overall basis based on information found in the quotation.
You are required to:
(i) Indicate, in the context of key factor, the maximum number of batches that could be
produced, if each of the alternatives namely buying A or B or C is considered.
(ii) Analyze the financial implication of purchase and advise which component is to be bought
keeping in view the fact that production capacity will be limited to a 50% increase.
(iii) Prepare a profit statement for the period assuming that the component chosen by you is
bought out and extra production is made and sold.
Solution
Working notes:
1. Present demand of components (in batches) from 10,800 (maximum) available machine
hours and projected estimates of components demand (in batches) in the next year.
Maximum available machine hours 10,800
Machine hours needed to manufacture components A, B and C
(per batch of ten numbers) for water purifier
Component
A 20 machine hours
B 28 machine hours
C 24 machine hours 72 hours
Present demand (in batches) of 150
Components A, B and C
(10,800 hours/ 72 hours)
Projected estimate of demand of components
A, B and C (add 50% increase)
In the next year.
Decision Making 76
2. Present and future fixed costs: Rs.
Present fixed cost of 150 batches
@ Rs. 200/- per batch 30,000
Add: increase in fixed cost to meet 50% increase in demand 10,000
Total future fixed cost for 225 batches 40,000
3. Expected purchase cost of components
View point probability Components
A B C
Expected Expected Expected
Price price price
Rs. Rs. Rs.
Pessimistic 0.25 30 50 40
(120 0.25) (200 0.25) (160 0.25)
Most likely 0.50 55 65 70
(110 0.50) (130 0.50) (140 0.50)
Optimistic 0.25 20 35 30
(80 0.25) (140 0.25) (120 0.25)
Total 105 150 140
4. Present contribution (per batch) Rs. Rs.
Selling price (per batch) 800
Less: Variable production cost 320
Variable assembly cost _50 _370
Contribution (per batch) 430
Total present contribution on 150 batches 64,500
(150 batches Rs. 430)
(i) Maximum no. of batches that could be produced in 10,800 machine hours if each of the three
alternatives namely buying A or B or C is considered respectively.
(a) Buy component A (from outside) No. Machine hours required.
Make component B 28 machine hours required.
Make component C __24 machine hours required.
Total _52
No. of batches that will be produced internally 207.69 batches (10,800 hours/52 hours)
(b) Buy component B (from outside) No. Machine hours required.
Make component A 20 machine hours required
Make component C _24 machine hours required.
_44
Number of batches that will be produced internally 245.45 batches (10,800 hours/44 hours)
But is view of projected (expected market) demand of 225 batches, production would be
restricted to 225 batches only.
(c) Buy component C (from outside) No. Machine hours required.
Make component A 20 Machine hours required.
Make component B _28 Machine hours required.
Total __48
No. of batches that could be produced internally 225 batches (10,800 machine hours/48
hours).
Decision Making 77
(ii) Statement of financial implication when purchases of component A, B and C are made from
outside (in view of the fact that production capacity will be limited to 50% increase).
Components bought A B C
Rs. Rs. Rs.
Total variable cost per batch (I) 64 108 116
Expected purchase cost (II) 105 150 140
(Refer to working note 3)
increase in variable cost (III) = (II I) 41 42 104
Existing contribution per batch (IV) 430 430 430
(Ref. To working note 4)
Revised contribution per batch (V) = (IV III) 389 388 406
Total revised contribution 80,791 87,300 91,350
(207.69 batches (225 batches (225 batches
Rs. 389) Rs. 388) Rs. 406)
Advise: Purchase component C from outside as it gives greatest contribution on manufacturing A
and B internally.
(iii) Profit statement (When C is bought from outside and A, B were manufactured internally and extra
production is made and sold).
Per batch Total (for 225 batches)
Rs. Rs.
Sales revenue (I) 800.00 1,80,000
(225 batches Rs. 800)
Less: Variable costs (Rs.) (per batch): (II)
Production cost of A Rs. 64
Production cost of B Rs. 108
Production cost of D Rs. 24
Production cost of E Rs. 8
Purchase cost of C Rs. 140
(Refer to working note 3) Rs. 344
Assembly cost Rs. 50 394.00 88,650
(225 batches 394)
Contribution (III) = (I II) 406.00 91,350
Less: Fixed costs 177.78 40,000
(40,000/225 batches)
(Refer to working note 2)
Profit 228.22 51,350
Risk analysis: Under Bayesian decision model a project can have two strategies involving the
same expected value but with different risk characteristics. In order to analyse as to which of the
projects involves greater risk, standard deviation method is used.
Critical path analysis: Under this method, the various activities or jobs involved in the
development and launching of new products are structured in the form of a network. Each activity
in turn is assigned a time and or cost. It shows that the project completion time is at the mercy of
few activities which are considered to be critical. It also shows that other activities can be
completed before critical activities are completed, so the project manager concentrated on the
time and cost involved in the completion of critical activities so that reduction in the duration of
such activities will lead to early completion of the project.
(d) Developing the product in a concrete form: This stage is important because it makes the
first attempt to develop the product in a concrete form. It involves four stages as under:
Decision Making 78
1. Engineering preparation of prototype that is trouble free designed for economical
manufacture and appealing to customer;
2. Consumer preference testing to seek the distribution or strength of consumer
preference.
3. Brand name to enable to identify the product; and
4. Packing to ensure product protection, economy and also to serve as a sales
promotional by using attractive packaging designs.
(e) Testing marketing: This is a stage where the entire product and marketing program is tried
out for the first time in small number of well chosen and authentic sales environments. The
primary motive of test marketing is to improve knowledge of potential sales. It can also
choose an alternative marketing plan after ascertaining marketing position.
(f) Commercialization: after passing all the aforesaid stages of development, the project
becomes ripe for commercial production. The firm by this time gains confidence in the
products future.
Product policy: A product policy is a significant factor in managerial decision because it is the
main spring of economic progress. It consists of three parts, namely:
(a) Product modification decision;
(b) Product elimination decision; and
(c) Product mix decision.
(a) Product modification decision: It consist of any deliberate alteration in this physical attributes
of a product or its packing. The factors which necessitate the manufactures to alter his
product are:
(i) Taking advantage of a new technological development.
(ii) Facing to competitive necessity, and
(iii) Rejuvenating a product suffering from declining sales, e.g. redesigning of packing to
increase the declining sales.
Product modification strategies
The following are three important product modification strategies:
i) Quality improvement: This is undertaken where the sales are declining due to poor quality of
product or to compete successfully with the other manufactures who supply product of good
quality.
ii) Feature improvement: It involves redesigning of the product so that it offers more
convenience, safety, efficiency or versatility. It serves as an effective means of building a
firms progressiveness and leadership.
iii) Style improvement: This strategy aims at improving the aesthetic appeal of the product in
contrast to its functional appeal. Changes in styles of motor vehicles are examples of this
strategy.
Product elimination decision: A weak product consumes more materials, uses productive
capacity and yet brings lesser sales revenue. Hence the need to estimate such weak products is
necessary. The cost of sustaining a weak product is as under:
(i) Un-recovered overhead,
(ii) Loss or profit,
Decision Making 79
(iii) Short production runs and expensive set up times, and
(iv) More attention of advertising and sales force time.
The elimination of a weak product is done by two methods namely, piece-meal basis and crisis
basis. Under piecemeal basis the loss becomes conspicuous and hence necessary to eliminate
the product whereas, under crisis basis, the need to eliminate the product arises because of
persistent decline in total sales, piling inventories, or rising costs. However, it is advisable to have
a periodic review system to eliminate the weak products and increase the overall companys
profit.
Product mix decision: Product mix means a composite of products offered for sales by a firm.
The firms final choice of a product strategy is based on its long run objective, viz., profits, sales,
stability and sales growth. To achieve these objectives the firm chooses an optimal product mix.
In order to arrive to arrive at the optimal product mix, the firm considers the following factors:
(a) An objective function which is normally maximization of profits or minimsation of cost;
(b) The constraints within which the objective function is to be achieved. These may be machine
capacity, raw materials availability, labour time, sales potential possible, etc.
When the constraints are many, we have to use the mathematical technique of linear
programming which again needs the use of a computer.
Product distribution decision: The objective of distribution may be stated as getting the right
goods to the places at the right time for the least cost. A manufacturer has to ensure maximum
customer service in order to maximize sales. Maximum customer service cannot, however, be
provided at minimum cost because if the customer service is to be made readily available, stock
level have to be increased and other costs have to be incurred. We are therefore required to
evolve an efficient system of distribution, which maximizes the ratio of output.
The basic output of a distribution system is the level of customer service. Customer service can
be defined as the number of days of delivery. In other words it can be defined as the percentage
of customers who should get their order in so many number of days. This level of service
depends up on an analysis of probable-customers, competitors and response to alternative levels
of service available.
The provision of a certain level of customer service incurring warehousing, costs, etc. these are
considered to be the inputs of a distribution system. A system can be considered to be an
efficient one if it maintains a particular level of service at a minimum of cost. This means freight
charges, warehousing cost, inventory carrying cost, etc. should be minimum.
We can use two mathematical models to improve the efficiency of a distribution system.
They are:
(i) Linear programming, and
(ii) Inventory models.
In order to minimize the cost of distribution, linear programming technique can be used. In order
to minimize the inventory carrying costs, inventory models can be used.