Question 3 Relevant costs (25 marks)

Kota Mills produces two types of brocade, silk and polyester. Last month 450 bolts of the polyester brocade and 4,000 bolts of the silk brocade were produced and sold. Average prices and costs for the two products for last month were:

	Brocade
	Polyester	Silk
Selling price	95	225
Direct materials	40	95
Direct labour	5	25
Variable overhead	5	15
Product line fixed costs	10	40
Corporate fixed costs	25	25
Average Margin per unit	10	25

The Kota brocade production line is highly automated. As a result, changes in production will have no impact on labour costs. The direct labour employees are all permanent and 40 hours per week checking the quality on the production line.

All costs, other than corporate fixed costs listed under each product line, can be avoided if either product line is dropped. Corporate fixed costs totals $125,000 per month. Corporate fixed costs of $10,000 can be avoided if the polyester were dropped. Corporate fixed costs of $15,000 can be avoided if the silk brocade is dropped. The remaining $100,000 can only be avoided by going out of business.

Haywood Mills has offered to supply the polyester brocade at a cost of $55 per bolt.

Required:

1. Calculate the total contribution margin for each product, assuming the sales mix is the same as last months. (3 marks)
2. Calculate the breakeven sales volume (in units produced and sold) for polyester brocade. In other words, what is the sales volume at which Kota should be financially indifferent between dropping and retaining the polyester brocade? (3 marks)
3. Calculate whether the Haywood Mills offer should be accepted on financial grounds. (4 marks)
4. Discuss at least five qualitative factors that would affect the decision to keep, drop or outsource the polyester brocade. (15 marks)