- 15 Marks
Question
BBY Limited manufactures jugs. They have just received an offer for the supply of the same product at ₦500 per jug. The plan is to manufacture 5,000 units within the next 3 months with the following budget:
| Expense | N’000 |
|---|---|
| Direct materials | 1,000 |
| Direct labour | 700 |
| Variable production overhead | 600 |
| Variable selling and distribution overhead | 700 |
| Fixed production overhead | 1,000 |
| Fixed selling and distribution overhead | 500 |
| Fixed admin overhead | 300 |
The special offer customer would pick up the products from the factory.
i. Advise whether the company should accept or reject the offer using the data above. Support your computation and decision with appropriate reasons.
ii. Would you make a different decision if the budget figures were as follows?
| Expense | N’000 |
|---|---|
| Direct materials | 1,030 |
| Direct labour | 925 |
| Variable production overhead | 645 |
| Variable selling and distribution overhead | 350 |
| Variable admin overhead | 430 |
| Fixed production overhead | 1,100 |
| Fixed selling and distribution overhead | 520 |
| Fixed admin overhead | 310 |
(Show your computations and state reasons for your decision).
Answer
i. Computation of Marginal Cost of Production
| Expense | N’000 |
|---|---|
| Direct materials | 1,000 |
| Direct labour | 700 |
| Variable production overhead | 600 |
| Total Marginal Cost | 2,300 |
Marginal cost per unit = 2,300,000 / 5,000 = ₦460 per unit
Since the marginal cost per unit (₦460) is lower than the offer price (₦500), the company should accept the offer.
Decision: Accept the offer as the marginal cost of production (₦460) is lower than the offer price (₦500).
ii. Computation of Marginal Cost of Production (New Figures)
| Expense | N’000 |
|---|---|
| Direct materials | 1,030 |
| Direct labour | 925 |
| Variable production overhead | 645 |
| Variable admin expense | 430 |
| Total Marginal Cost | 3,030 |
Marginal cost per unit = N3,030,000/5000 = N530 per unit
Decision: The company should reject the offer as the marginal cost of production,
N530, is higher than the ₦500 offer.
- Tags: Cost Analysis, Make or buy decisions, Special Order
- Level: Level 1
- Topic: Decision-making techniques
- Series: MAY 2023
- Uploader: Theophilus