P4–14 Make or buy decision Time allowed: 40 minutes Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed.

However, Silven’s president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.

The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for £8 per box. Because of excess capacity, no additional fixed overhead costs will be incurred to produce the product. However, a £90,000 charge for fixed overhead will be absorbed by the product under the company’s absorption costing system. Using the estimated sales and production of 100,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box:

The costs above include costs for producing both the lip balm and the tube into which the lip balm is to be placed. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be £1.35 per box of 24 tubes. If Silven Industries accepts the purchase proposal, it is predicted that direct labour and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and that direct materials costs would be reduced by 25%.
Required 1 Should Silven Industries make or buy the tubes? Show calculations to support your answer.
2 What would be the maximum purchase price acceptable to Silven Industries? Support your answer with an appropriate explanation.
3 Instead of sales of 100,000 boxes, revised estimates show sales volume at 120,000 boxes. At this new volume, additional equipment at an annual rental of £40,000 must be acquired to manufacture the tubes. Assuming that the outside supplier will not accept an order for less than 100,000 boxes, should Silven Industries make or buy the tubes? Show computations to support your answer.
4 Refer to the data in Question 3 above. Assume that the outside supplier will accept an order of any size for the tubes at £1.35 per box. How, if at all, would this change your answer? Show computations.
5 What qualitative factors should Silven Industries consider in determining whether they should make or buy the tubes?

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Direct material Direct labour Manufacturing overhead Total cost 3.60 2.00 1.40 7.00