Question

The Svenson Corporation manufactures cellular modems. It manufactures its own cellular modem circuit boards (CMCB), an important part of the cellular modem. It reports the following cost information about the costs of making CMCBs in 2014 and the expected costs in 2015:
Current Costs in 2014 Expected Costs in 2015
Variable manufacturing costs
Direct material cost per CMCB $180 $170
Direct manufacturing labor cost per CMCB 50 45
Variable manufacturing cost per batch for setups, materials handling, and quality control 1,600 1,500
Fixed manufacturing cost
Fixed manufacturing overhead costs that can be avoided if CMCBs are not made 320,000 320,000
Fixed manufacturing overhead costs of plant depreciation, insurance, and administration that cannot be avoided even if CMCBs are not made 800,000 800,000
Svenson manufactured 8,000 CMCBs in 2014 in 40 batches of 200 each. In 2015, Svenson anticipates needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.
The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2015 at$300 per CMCB on whatever delivery schedule Svenson wants.
1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2015.
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases CMCBs from Minton. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton? Show your calculations.
3. Now suppose that if Svenson purchases CMCBs from Minton, its best alternative use of the capacity currently used for CMCBs is to make and sell special circuit boards (CB3s) to the Essex Corporation. Svenson estimates the following incremental revenues and costs from CB3s:
Total expected incremental future revenues $2,000,000
Total expected incremental future costs $2,150,000
4. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from Minton? Show your calculations.

Answer 1

Answer:

Expected manufacturing costs 2015:

direct materials $170 per unit x 10,000 = $1,700,000

direct labor $45 per unit x 10,000 = $450,000

variable overhead per batch $1,500 x 80 batches = $120,000

fixed overhead:

avoidable $320,000

not avoidable $800,000

1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2015.

$1,700,000 + $450,000 + $120,000 + $320,000 + $800,000 = $3,390,000

cost per unit = $3,390,000 / 10,000  units = $339 per unit

2. Svenson should keep manufacturing the CMCBs:

costs if CMCBs are purchased from Minton = ($300 x 10,000) + $800,000 = $3,000,000 + $800,000 = $3,800,000

the cost of purchasing is $410,000 higher than the cost of manufacturing.

3. if Svenson manufactures CB3s, its total incremental costs will be higher than the total incremental revenues, so they should not produce CB3s:

incremental revenue - incremental costs = $2,000,000 - $2,150,000 = -$150,000 (loss)

4. Svenson should keep manufacturing CMBCs because the incremental costs of manufacturing are lower than the incremental costs of purchasing the circuits.

Incremental costs                   Manufacturing           Purchasing

buying from Minton                                                   $3,000,000

direct materials                        $1,700,000

direct labor                                $450,000

variable overhead                     $120,000

fixed overhead                         $320,000

total                                        $2,590,000      <       $3,000,000  

The $800,000 in unavoidable fixed costs are added to both sides, so they do not make any difference in the analysis.

Since producing the CB3s is not profitable, the best option is to leave the spare capacity idle, so there is no opportunity cost associated to producing or buying the circuits.