Problem

Make or Buy Decision

Silven Industries, which manufactures and sells a highly successful line of summer lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A natural area for the company to consider is the production of winter lotions and creams to prevent dry and chapped skin.

After considerable research, a winter products line has been developed. However, Silven's president has decided to introduce only one of the new products for this coming winter. If the product is a success, further expansion in future years will be initiated.

The product selected (called Chap-Off) is a lip balm that will be sold in a lipstick-type tube. The product will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the product. However, a $60,000 charge for fixed manufacturing overhead will be absorbed by the product under the company's absorption costing system.

Using the estimated sales and production of 120,000 boxes of Chap-Off, the Accounting Department has developed the following cost per box:

Direct materials $ 3.50
Direct labor 2.00
Manufacturing overhead 1.40
Total cost $ 6.90

The costs above include costs for producing both the lip balm and the tube that contains it. As an alternative to making the tubes, Silven has approached a supplier to discuss the possibility of purchasing the tubes for Chap-Off. The purchase price of the empty tubes from the supplier would be $1.35 per box of 24 tubes. If Silven Industries accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of Chap-Off would be reduced by 10% and direct materials costs would be reduced by 25%.

Required:

1a. Calculate the total variable cost of producing one box of Chap-Off?

1b. Assume that the tubes for the Chap-Off are purchased from the outside supplier, calculate the total variable cost of producing one box of Chap-Off?

1c. Should Silven Industries make or buy the tubes?

Make
Buy

2. What would be the maximum purchase price acceptable to Silven Industries?

3. Instead of sales of 120,000 boxes, revised estimates show a sales volume of 150,000 boxes. At this new volume, additional equipment must be acquired to manufacture the tubes at an annual rental of $42,000. Assume that the outside supplier will not accept an order for less than 150,000 boxes.

a. Calculate the total relevant cost of making 150,000 boxes and total relevant cost of buying 150,000 boxes.

b. Based on the above calculations, should Silven Industries make or buy the boxes?

Buy
Make

4. Refer to the data in (3) above. Assume that the outside supplier will accept an order of any size for the tubes at $1.35 per box. Which of these is the best alternative?

Make all 150,000 boxes
Buy all 150,000 boxes
Make 120,000 boxes and buy 30,000 boxes
Make 75,000 boxes and buy 75,000 boxes.