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- 20 Marks
Question
Agrow Ltd is a community company that manufactures and sells car components; Wiper, Driving mirror, and Brake pad. The budgeted information for the next year is expected to be as follows:
| WIPERS | DRIVING MIRROR | BRAKE PAD | |
|---|---|---|---|
| Production (units) | 50,000 | 25,000 | 35,000 |
| GH¢ | GH¢ | GH¢ | GH¢ |
| Selling price per unit | 34 | 30 | 28 |
| Direct material per unit | 9 | 10 | 5 |
| Direct labour cost per unit | 18 | 3 | 12 |
| Variable production overhead | 1 | 2 | 1 |
Direct labour is paid at GH¢12 per hour. While other production factors are unlimited, labour is limited to 102,500 hours. Hence, an extra component must be purchased from an external supplier.
Total fixed cost per annum is expected to be as follows:
| Cost | GH¢ |
|---|---|
| Incurred as a direct consequence of making any quantity of Wiper | 140,000 |
| Incurred as a direct consequence of making any quantity of Driving mirror | 255,000 |
| Incurred as a direct consequence of making any quantity of Brake pad | 150,000 |
| Other Fixed Cost | 60,000 |
| Total Fixed Cost | 605,000 |
An external supplier has offered to supply a unit of the following at their respective prices:
| Component | GH¢ |
|---|---|
| Wiper | 32 |
| Driving mirror | 24 |
| Brake pad | 23 |
Required:
a) Advise which of the products Agrow Ltd should make in-house or outsource. (7 marks)
b) Recommend the quantities that Agrow Ltd should make and the quantities it should buy externally to obtain the required quantities of all the parts and calculate the total annual cost. (10 marks)
c) State THREE (3) factors to consider before setting a selling price of a product. (3 marks)
(Total: 20 marks)
Answer
a) Make or Buy Decision for Agrow Ltd
| Component | Wiper | Driving Mirror | Brake Pad |
|---|---|---|---|
| Marginal cost per unit (GH¢) | 28 | 15 | 18 |
| Demand (units) | 50,000 | 25,000 | 35,000 |
| Total variable cost | 1,400,000 | 375,000 | 630,000 |
| Cost incurred as a direct consequence of making | 140,000 | 255,000 | 150,000 |
| Total cost of making the product | 1,540,000 | 630,000 | 780,000 |
| Cost of buying: | |||
| 50,000 x GH¢32 | 1,600,000 | ||
| 25,000 x GH¢24 | 600,000 | ||
| 35,000 x GH¢23 | 805,000 | ||
| Cost saving / (extra) for making the product | 60,000 | (30,000) | 25,000 |
Decision:
- Wiper: Make in-house (as the cost saving is GH¢60,000).
- Driving Mirror: Buy externally (as buying saves GH¢30,000).
- Brake Pad: Make in-house (as the cost saving is GH¢25,000).
(7 marks)
b) Production and Purchase Plan for Agrow Ltd
| Product | Quantity | Contribution per unit | Labour hour per unit | Contribution per labour hour | Rank |
|---|---|---|---|---|---|
| Wiper | 50,000 | GH¢6 | 1.5 | GH¢4 | 2nd |
| Brake Pad | 35,000 | GH¢10 | 1 | GH¢10 | 1st |
Production Plan:
| Product | Quantity to Make | Labour Hours | Hours Available |
|---|---|---|---|
| Brake Pad | 35,000 | 35,000 | |
| Wiper | 45,000 | 67,500 | |
| Total Hours | 102,500 |
Buying Plan:
- Wiper: Buy 5,000 units.
- Driving Mirror: Buy 25,000 units.
Total Annual Cost:
| Product | Quantity | Cost per unit (GH¢) | Total Cost (GH¢) |
|---|---|---|---|
| Brake Pad (make) | 35,000 | 18 | 630,000 |
| Wiper (make) | 45,000 | 28 | 1,260,000 |
| Wiper (buy) | 5,000 | 32 | 160,000 |
| Driving Mirror (buy) | 25,000 | 24 | 600,000 |
| Direct consequence of making Wiper | – | – | 140,000 |
| Direct consequence of making Brake Pad | – | – | 150,000 |
| Other Fixed Cost | – | – | 60,000 |
| Total Cost | 3,000,000 |
(10 marks)
c) Factors to Consider in Setting a Selling Price
- Cost of production: Ensures that the selling price covers all costs and yields a profit.
- Price of competing firms: Helps to position the product competitively in the market.
- Purchasing power of customers: Ensures the price is aligned with what customers can afford.
(3 marks)
Total Marks for Question 5: 20 marks
- Tags: Cost Analysis, Make or buy decision, Production planning
- Level: Level 2
- Topic: Decision-making techniques
- Series: MAY 2021
- Uploader: Dotse