About relevant cost for decision making

Apr 25, 2020
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Hong Kong
Hi, here i only want to ask about HT4. I calculated the Contribution/kg of R2 ($) for XY5 is $3.17.

Below is the question, it's quite long:-

The managers of Albion plc are reviewing the operations of the company with a view to making operational decisions for the next month. Details of some of the products manufactured by the company are given below.

Selling price ($/unit)21.0028.5027.30
Material R2 (kg/unit)
Material R3 (kg/unit)
Direct labour (hours/unit)
Variable production overheads ($/unit)1.101.301.101.40
Fixed production overheads ($/unit)1.501.601.701.40
Expected demand for next month (units)9501,000900

Products AR2, GL3 and HT4 are sold to customers of Albion plc, while Product XY5 is a component that is used in the manufacture of other products. Albion plc manufactures a wide range of products in addition to those detailed above.

Material R2, which is not used in any other of Albion's products, is expected to be in short supply in the next month because of industrial action at a major producer of the material. Albion plc has just received a delivery of 5,500 kg of Material R2 and this is expected to be the amount held in stock at the start of the next month. The company does not expect to be able to obtain further supplies of Material R2 unless it pays a premium price. The normal market price is $2.50 per kg.

Material R3 is available at a price of $2.00 per kg and Albion plc does not expect any problems in securing supplies of this material. Direct labour is paid at a rate of $4.00 per hour.

Folam Limited has recently approached Albion plc with an offer to supply a substitute for Product XY5 at a price of 10.20 per unit. Albion plc would need to pay an annual fee of 50,000 for the right to use this patented substitute.

(a) Determine the optimum production schedule for Products AR2, GL3 and HT4 for the next month, on the assumption that additional supplies of Material R2 are not purchased.



(b). If Albion plc decides to purchase further supplies of Material R2 to meet demand for Products AR2, GL3 and HT4, what should be the maximum price per kg that the company is prepared to pay?

Answer: Further supplies of Material R2 will be used to produce additional units of Product HT4. The contribution per kg of Material R2 of Product HT4 is $3·17 and so if Albion pays 3·17 + 2·50 = $5·67 per kg for Material R2, the additional units of Product HT4 produced will make a zero contribution towards fixed costs. $5·67 is therefore the maximum price.

MY question: If the contribution of HT4 is $3.17, would't $3.17 be the maximum price that the company would like to purchase? so that it will lost the whole contribution. why need to add $2.5, the price of Material R2??



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