The Vermont Corporation, which produces and sells to wholesalers 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 in the production of cold lotions and creams to prevent dry and chapped skin.
After considerable research, a cold product line has been developed. However, because of the conservative nature of the company management, Vermont president has decided to introduce only one of the new products for this coming cold season. If the product is a success, further expansion is future years will be initiated.
The product selected (called Chap-off) is lip balm that will sold a lipsticks type tube. The product will be sold to wholesalers in boxes of 4 tubes for P8.00 per box. Because of available capacity no additional fixed charge to produce the product. However, a 100,000 fixed charge will be absorbed by the product to allocate a share of the company’s present fixed costs to the new product.
Using the estimated sales and production of 100,000 boxes of Chap-off as the standard volume, the accounting department has developed the following costs:
Direct materials 3.00 per box
Direct labor 2.00 per box
Total overhead 1.50 per box
Total 6.50 per box
Vermont has approached a cosmetics manufacturer to discuss the possibility of purchasing the tubes for Chap-off. The purchase price of the empty tubes from the manufacturer would be P0.90 per 4 tubes. If Vermont accepts the purchase proposal, its is estimated that direct labor and variable overhead costs would be reduced by 10% and direct material costs would be reduced by 20%.
1. Should Vermont Corporation make or buy the tubes? Show calculations to support your answer.
2. Instead of sales of 100,000 boxes, revised estimates show sales volume at 125,000 boxes. At this new volume additional equipment, at an annual rental of 10,000, must be acquired to manufacture the tubes. However, this incremental cost would the only additional fixed costs required even if sales increased to 300,000 boxes. Under these circumstances, should Vermont make or buy the tubes? Show calculations to support your answer.