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 $670 per ton. In the past, the company has sold only part of its cracked wheat as cereal and has retained the rest for further milling into flour. The flour has been selling for $886 per ton, but recently the price has become unstable and has dropped to $811 per ton. The costs and revenues associated with a ton of flour follow:
|
Per Ton of Flour |
| Selling price |
|
$ |
811 |
| Cost to manufacture: |
|
|
|
| Raw materials: |
|
|
|
| Enrichment materials |
$ 77 |
|
|
| Cracked wheat |
656 |
|
|
|
|
|
|
| Total raw materials |
733 |
|
|
| Direct labor |
26 |
|
|
| Manufacturing overhead |
60 |
|
819 |
|
|
|
|
| Manufacturing profit (loss) |
|
$ |
(8) |
|
|
|
|
|
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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.
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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 into 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 |
| Selling price |
|
$ |
670 |
| Cost to manufacture: |
|
|
|
| Wheat grain |
$ 570 |
|
|
| Direct labor |
26 |
|
|
| Manufacturing overhead |
60 |
|
656 |
|
|
|
|
| Manufacturing profit |
|
$ |
14 |
|
|
|
|
|
|
The sales manager argues that because the present $811 per ton price for the flour results in a $8 per ton loss, the milling of flour should not be resumed until the price per ton rises above $819.
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The company assigns manufacturing overhead cost to the two products on the basis of milling hours. The same amount of time is required to mill either a ton of cracked wheat or a ton of flour. Virtually all manufacturing overhead costs are fixed. Materials and labor costs are variable.
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The company can sell all of the cracked wheat and flour it can produce at the current market prices.
1a. Calculate the Contribution margin per ton of flour.
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1b. 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 $811 per ton?
2. What is the lowest price that the company should accept for a ton of flour?
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