Utilization of a Constrained Resource

Westburne Company produces three products: Alpha, Omega and Beta. Data (per unit) concerning the three products follow:

Alpha Omega Beta

Selling price $160 $112 $140

Less variable expenses:

Direct materials 48 30 18

Labour and overhead 48 54 80

Total variable expenses 96 84 98

Contribution margin $64 $28 $42

Contribution margin ratio 40% 25% 30%

Demand for the company's products is very strong, with far more orders each month than the company can produce with the available raw materials. The same material is used in each product. The material costs $6 per kilogram, with a maximum of 10,000 kilograms available each month.

Required:

Which orders would you advise the company to accept first, those for Alpha, Omega or Beta? Which orders second? Third?

No. 2

Dropping or Retaining a Tour

A study has indicated that some of the bus tours operated by Clear Water Tours Inc. are not profitable. As a result, consideration is being given to dropping these unprofitable tours to improve the company's overall operating performance.

One such tour is a three-day Majestic Islands bus tour. Additional information and an income statement from a typical Majestic Islands tour are given below.

The following additional information is available about the tour:

1. Bus drivers are paid fixed annual salaries; tour guides are paid for each tour conducted.
2. The "Bus maintenance and preparation" cost in the statement is an allocation of the salaries of mechanics and other service personnel who are responsible for keeping the company's fleet of buses in good operating condition.

Ticket revenue (100 seat capacity X 40% occupancy X

$70 ticket price per person) $2,800 100%

Variable expenses ($21.00 per person) 840 30

Contribution margin 1,960 70%

Tour expenses:

Tour promotion 540

Salary of bus driver 320

Fee, tour guide 630

Fuel for bus 110

Depreciation of bus 410

Liability insurance, bus 180

Overnight parking fees, bus 50

Room and meals, bus driver and tour guide 160

Bus maintenance and preparation 270

Total tour expenses 2,670

Operating loss $(710)

1. Depreciation of buses is due to obsolescence.
2. Liability insurance premiums are based on the number of buses in the company's fleet.
3. Dropping the Majestic Islands bus tour would not allow Clear Water Tours to reduce the number of buses in its fleet, the number of bus drivers on the payroll, or the size of the maintenance and preparation staff.

Required:

1. Prepare an analysis showing what the impact will be on the company's profits if this tour is discontinued.
2. The company's tour director has been criticized because only about 50% of the seats on Clear Water's tours are being filled, compared to an industry average of 60%. The tour director has explained that Clear Water's average seat occupancy could be improved considerably by eliminating about 10% of its tours, but that doing so would reduce profits. Explain how this could happen.

No. 3

Accept or Reject a Special Order

Moore Company manufactures and sells a single product called a Lop. Operating at capacity, the company can produce and sell 30,000 Lops per year. Costs associated with this level of production and sales are given below:

Unit Total

Direct materials $15 $450,000

Direct labour 8 240,000

Variable manufacturing overhead 3 90,000

Fixed manufacturing overhead 9 270,000

Variable selling expense 4 120,000

Fixed selling expense 6 180,000

Total cost $45 $1,350,000

The Lops normally sell for $50 each. Fixed manufacturing overhead is constant at $270,000 per year within the range of 25,000 through 30,000 Lops per year.

Required:

1. Assume that due to a recession, Moore Company expects to sell only 25,000 Lops through regular channels next year. A large retail chain has offered to purchase 5,000 Lops if Moore is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; so variable selling expenses would be slashed by 75%. However, Moore Company would have to purchase a special machine to engrave the retail chain's name on the 5,000 units. This machine would cost $10,000. Moore Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.
2. Refer to the original data. Assume again that Moore Company expects to sell only 25,000 Lops through regular channels next year. The provincial government would like to make a one-time- only purchase of 5,000 Lops. The government would pay a fixed fee of $1.80 per Lop, and it would reimburse Moore Company for all costs of production (variable and fixed) associated with the units. Since the government would pick up the Lops with its own trucks, there would be no variable selling expenses associated with this order. If Moore Company accepts the order, by how much will profits increase or decrease for the year?
3. Assume the same situation as that described in (2) above, except that the company expects to sell 30,000 Lops through regular channels next year, so accepting the government's order would require giving up regular sales of 5,000 Lops. If the government's order is accepted, by how much will profits increase or decrease from what they would be if the 5,000 Lops were sold through regular channels?

No. 4

Make or Buy a Component

Current-Control, Inc., manufactures a variety of electrical switches. The company is currently manufacturing all of its own component parts. An outside supplier has offered to sell a switch to Current- Control for $32 per unit. To evaluate this offer, Current-Control, Inc., has gathered the following information relating to its own cost of producing the switch internally:

Per 12,000 Units

Unit per Year

Direct materials $12 $144,000

Direct labour 10 120,000

Variable manufacturing overhead 3 36,000

Fixed manufacturing overhead, traceable 8* 96,000

Fixed manufacturing overhead, common, but allocated 16 192,000

Total cost $49 $588,000

*25% supervisory salaries; 75% depreciation of special equipment (no resale value).

Required:

1. Assuming that the company has no alternative use for the facilities now being used to produce the switch, should the outside supplier's offer be accepted? Show all computations.
2. Suppose that if the switches were purchased, Current-Control, Inc., could use the freed capacity to launch a new product. The segment margin of the new product would be $78,000 per year. Should Current-Control, Inc., accept the offer to buy the switches from the outside supplier for $32 each? Show computations.