12-33

Midwest Mills has a plant that can mill wheat grain into a cracked wheat cereal and then further mill the cracked wheat into flour. The company can sell all the cracked wheat cereal that it can produce at a selling price of $490 per ton. In the past, the company has sold only the part of its cracked wheat as cereal and has retained the rest for further milling into flour. The flour has been selling for $700 per ton, but recently the price has become unstable and has dropped to $625 per ton. The costs and revenues associated with a ton of flour follow:

	Per Ton of Flour	Per Ton of Flour
Selling Price		$625
Cost of Manufacture
Raw Materials:
Enriched Materials	$80
Cracked Wheat	$470
Total Raw Materials:	$550
Direct Labor	$20
Manufacturing Overhead:	$60	630
Manufacturing Profit (loss)		(5)

Because of the weak price for flour, the sales manager believes that the company should discontinue milling flour and use its entire milling capacity to produce cracked wheat to sell as cereal. The same milling equipment is used for both products. Milling one ton of cracked wheat into one ton of flour requires the same capacity as milling one ton of wheat grain int one ton of cracked wheat. Hence, the choice is between one ton of flour and two tons of cracked wheat. Current cost and revenue data on the cracked wheat cereal follow:

	Per Ton of Cracked Wheat	Per Ton of Cracked Wheat
Selling Price		$490
Cost to Manufacture
Wheat Grain	$390
Direct Labor	$20
Manufacturing Overhead	$60	470
Manufacturing Profit		$20

The sales manager argues that becuase the present $625 per ton price for the flour results in a $5 per ton loss, the milling of flour should not be resumed until the price per ton rises above $630. The company assigns manufacturing overhead cost to the two products on the basis of milling hours. The same amount of itme is required for both products. Virtually, all manufacutring overhead costs are fixed. Materials and labor costs are variable. The company can call all of the cracked wheat and flour it can produce at the current market prices.

1. Do you agree with the sales manager that the company should discontinue milling flour and use the entire milling capacity to mill cracked wheat if the price of flour remains at $625 per ton? Support your answer with computations and explanations.

2. What is the lowest price that the company should accept for a ton of flour? Again, support your answer with computations and explanations.