The management of Pink Engineering bv (PEbv), a business based in the Netherlands, is currently considering its budget for the financial year commencing on 1 June. PEbv manufactures some specialist equipment for various contractors involved the defence industry so all of its products have code names. Discussions between the purchasing, sales and manufacturing departments are focusing on the desirability of continuing to manufacture the Kay and Ell final products and the two component assemblies, Emm1 and Emm2 (neither of which are included in the Kay and Ell products).

To assist the budget process, the CFO has provided the following cost data, based on the Chief Operating Officers current planned output

Product name	Kay $	Ell $	Emm1 $	Emm2 $
Direct material	175	725	75	40
Direct labour	44	88	20	12
Variable overhead	75	107	31	15
Fixed overhead	77	154	35	21
Total	371	1074	161	88

The purchasing director has obtained quotations from outside suppliers for both final products and both assemblies, as follows:

Kay: 297$

Ell: 940$

Emm1: 127$

Emm2: 72$

The sales director has indicated that there are strong competitive pressures at work which will restrict the achievable unit selling price for the Kay to 360 and the Ell to 945. Therefore, his view is that the manufacture of both products should be terminated because unit cost exceeds unit selling price.

Fixed overheads are apportioned to all products and assemblies on the basis of 175% of direct labour cost. PEbv manufactures a wide range of other products and assemblies.

The Chief Operating Officer advises that, unless advised to the contrary, her manufacturing budget for next year comprises

Kay: 5,000 units

Ell: 4,000 units

Emm1: 7,000 units

Emm2: 6,000 units

In the event of the manufacture of Emm1 being discontinued, she has identified that 21,000 of fixed overhead will be saved over the year.

However, she is also concerned that output will be limited due to potential operational difficulties (shortages of spares) on a key machine involved in the manufacture of all of these items.

Budgeted machine usage per item is:

Kay 15 Hours per unit

Ell 12.5 Hours per unit

Emm1 3.5 Hours per unit

Emm2 1.2 Hours per unit

1. Advise the management on the desirability of manufacturing or sub-contracting the two components Emm1 and Emm2. Outline the reasoning behind your recommendations.

2. Advise the management of the profitability of Kay and Ell, indicating whether it should continue to manufacture or sub-contract them out. Outline the reasoning behind your recommendations.

3. If the operational difficulties of the key machine limit the available machine hours to 97,200, review the recommendations made in (1) and (2) above and prepare an optimal production plan for the year to maximise profitability. You do not require to calculate the profit.