The Enhanced Products Division of Forrest Industries makes ceramic pots that are used to hold large decorative plants. During the current year, the division produced 10,000 pots and incurred the following costs: Unit-level materials costs (10,000 @ $15)$150,000 Unit-level labor costs (10,000 @ $20) 200,000 Unit-level overhead costs (10,000 @ $16) 160,000 Depreciation expenses on equipment* 12,000 Other manufacturing overhead** 36,000 *The equipment was purchased on January 1 last year for $60,000 and has a current book value of $48,000, a remaining useful life of four years, and a zero salvage value. If the equipment is not used to produce ceramic pots, it can be leased for $8,000 per year.**Includes supervisors' salaries and rent for manufacturing plant.Required:1)
Assume Forrest Industries uses a cost plus pricing strategy. What price should be charged for the ceramic pot product if the division sets its price 40% above the unit product cost? 2) A potential overseas customer who would not compete with the division's existing customers would like to purchase 1,000 ceramic pots but is not willing to pay the regular price. At what selling price would the division be indifferent about accepting the special order? 3) Suppose the division has the opportunity to purchase the ceramic pot from another manufacturer for $60. The supplier is willing to hold sufficient inventories to meet Forrest's demand. Should the division outsource its ceramic pots? Why or why not?
What will be an ideal response?
1) The ceramic pot should sell at $78.12, computed as follows:
| Unit-level materials costs (10,000 @ $15) | $ | 150,000 | |
| Unit-level labor costs (10,000 @ $20) | 200,000 | ||
| Unit-level overhead costs (10,000 @ $16) | 160,000 | ||
| Depreciation expenses on equipment | 12,000 | ||
| Other manufacturing overhead | 36,000 | ||
| Total product costs | $ | 558,000 |
The cost per unit is $55.80 ($558,000 ÷ 10,000 units)
The selling price is $78.12 ($55.80 × 1.40)
2) The incremental cost of making the 1,000 ceramic pots is computed as follows:
| Unit-level materials costs (1,000 @ $15) | $ | 15,000 | |
| Unit-level labor costs (1,000 @ $20) | 20,000 | ||
| Unit-level overhead costs (1,000 @ $16) | 16,000 | ||
| Total product costs | $ | 51,000 |
The division should be indifferent at a price of $51.00 ($51,000/1,000). Any price above $51 will generate profit for the division.
3) The relevant cost of making the ceramic pots is $55.40, computed as follows:
| Unit-level materials costs (10,000 @ $15) | $ | 150,000 | |
| Unit-level labor costs (10,000 @ $20) | 200,000 | ||
| Unit-level overhead costs (10,000 @ $16) | 160,000 | ||
| Other manufacturing overhead | 36,000 | ||
| Opportunity cost of leasing the equipment | 8,000 | ||
| Total product costs | $ | 554,000 | |
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