CHAPTER XVII

DECISIONS INVOLVING ALTERNATIVE CHOICES

SOLUTION TO SELF EVALUATION PROBLEMS
SOLUTION 1
Marginal Cost For The Current Year
Direct material

4.20

Direct wages

1.20

Variable overheads:
Works overhead

3.00

Sales overhead

0.25

Total marginal cost

8.65

Contribution per unit

6.35

Selling price

15.00
Statement of Profit on Sales of 60,000 Units
Rs.

Sales
9,00,000
Less: Variable cost (60,000 x 8.65)
5,19,000
Contribution
3,81,000
Less: Fixed costs:
Works overheads (1,80, 000 + 18,000)

1,98,000

Sales overheads (45,000 + 4,500)

49,500

2,47,500
Profit
1,33,500
Profit required

1,80,500

Profit on 60,000 units

1,33,500

Profit to be earned on 20,000 units

Rs. 47,000

Statement of Minimum Selling Price Per Unit For an Order of 20,000

Rs.
costs 20,000 x 8.65

1,73,000

Desired profit

47,000

Total sales

2,20,000

Selling price per unit = 2,20,000 =

Rs.11

20,000
The above can be verified as under:
Sales 60,000 units x 15 =

9,00,000

20,000 units x 11 =

2,20,000

Less:

11,20,000

Variable costs: 80000 x 8.65 =

6,92,000

Fixed costs =

2,47,500

Profit

9,39,500
1,80,500

SOLUTION 2
(a)
Statement Showing the Variable Cost and Purchase Cost of Component...
Used by Auto Link Ltd.
Variable Cost
Materials
Labour
Expenses
Total variable cost (when component is
produced)
Cost of purchase (when component is

Per Unit for

Total

90,000 units Rs.

270
135
90
495

Rs.
24300000
12150000
8100000
44550000

540

48600000

purchased)
Difference, excess of purchase price over

45

variable cost

4050000

Fixed expenses not being affected, it is evident from the above statement that if
the component is purchased from the outside supplier, the company will have to spend
Rs. 45 per unit more and on 90,000 units, the company will have to spend Rs. 40,50,000
more. Therefore, the company should not stop the production of the component.
(b)

The following statement shows the cost implications of the proposal to divert the
available facilities for a new product.
Statement showing the contribution per unit if the existing resources are

used for the production of another new product:

(Rs.)
(Rs.)
Selling price of the new product per unit
485
Less: Materials cost

200

Labour (variable)

135

Expenses (variable)

90

425
Contribution per unit
60
Loss per unit if the present component is purchased:
Purchase price of the existing product
540
Less: Total variable cost of producing the existing component
495
Excess cost

45

Thus, if the company diverts its resources for the production of another new
product, it will benefit by Rs. 15, i.e. Rs. 60 - 45 per unit. On 90,000 units, the company
will save Rs. 13,50,000. Therefore, it is advisable to divert the resources to manufacture the
new product and the component presently being produced should be purchased from the
market. This is also brought out by the following figures:
Rs.

Total cost producing the component 90,000 x 675 A

6,07,50,000

Cost of purchasing the component 90,000 x 540

4,86,00,000

Fixed expenses, not having been saved 90,000 x 180, i.e.675-495

1,62,00,000
6,48,00,000

Less: Contribution from the new product 90,000 x 60

54,00,000

Total cost if component is purchased and new product is

purchased and new prduct is made B

5,94,00,000

Savings A B

1350000

SOLUTION 3
i

Economies of two export proposals:

Order from Canada

Order from Middle

for Product A

East for Product B

Marginal cost per unit:

Materials
Labour
Variable factory overheads

2.00
4.00
3.00

4.00
4.00
1.20

Variable selling and administration

3.20

3.00

Overheads
Special packing charges
Total variable cost
Export price per unit
Contribution per unit

0.50
12.70
17.50
4.80

0.50
12.70
15.50
2.80

Since machine hour is the limiting (key) factor, the contribution should be linked
with the machine hours. This has been worked out as follows:
Machine hour per unit

2.5 hours

1.5 hours

Contribution per machine hour

Rs. 1.92

Rs. 2.13

Product B yields a better contribution per machine hour.

The order from the Middle East should therefore be accepted as compared to the
Canadian offer.
Working Notes:
Factory overheads per unit

A
Rs. 5

B
Rs.3

Total

Machine hour rate per hour

Rs.2
Units Produced
600
Machine hours utilized
1500
Level of activity
Machine hours at 100 % activity : 2,100 x 100 = 2,800 hr.

Rs.2
400
600

2100
75%

75
Capacity hours available for export 2,800 2,100 = 700 hr.

(ii)

Statement of Overall Profitability

Units
Materials
Labour Based on capacity
Factory overhead:
Variable
Fixed
Selling & Admn. Overheads:
Variable
Fixed
Special packing
Total costs
Sales
Profit

Product A

Product B

Total

600 Rs.
1200
2400

867 Rs.
3468
1600

Rs.
4668
4000

1800
1200

1561
480

3361
1680

1920
2880

11400
13800
2400

1734
1200
234
10277
14839
4562

3654
4080
234
21677
28639
6962

Working notes
1.

2.

Number of units of B:
Sales in the home market

400

Export market 700 hr/1.5

467

Total

867

Sales values of B:
400 units in the home market @ Rs. 19

Rs. 7600

467 units for export @ Rs. 15.50

Rs.7839

Total:

Rs. 14,839

SOLUTION 4
Decision analysis (continue or shut down the factory):
Amount in Lakh
Particulars

Operate the

Shut-down the

Differential

factory

factory

revenue and

18.51

costs
18.51

6.40
4.80
0.96
0.32

6.00

6.40
4.80
0.96
0.12

(variable)
Administrative expenses (fixed)
Selling' and distribution expenses

3.24
0.48

3.24
0.48

(variable)
Selling and distribution expenses

3.36

3.36

Sales revenue
Cost:
Direct material
Direct labour
Factory expenses (variable)
Administrative
expenses

(fixed)
Closing down costs:
Redundancy payments

2.00
Maintenance of plant

0.50
Overhauling costs

0.80
Total Cost
19.56
9.30
Differential revenue favouring the decision to operate the plant

2.00
0.50
0.80
10.26