Grace greeting cards incorporated is starting a new business venture and are in the process of evaluating its product lines.

Information for one new product, traditional parchment grade cards, is as follows:

Sixteen times each year, a new card design will be put into production. Each new design will require $600 in setup costs.

The parchment grade card product line incurred $75,000 in development costs and is expected to be produced over the next four years.

Direct costs of producing the designs average $0.50 each.

Indirect manufacturing costs are estimated at $50,000 per year.

Customer service expenses average $0.10 per card.

Current sales are expected to be 2,500 units of each card design.

Each card sells for $3.50.

Sales units equal production units each year.

What are the estimated life-cycle revenues?

workings
Total No of Cards Sold / 16 design X 2,500 cards X 4 Years / 160,000
cards
($) / ($)
Total Estimated Lifecycle Sales / 160,000 cards X $3.50 / 560,000
Less : Total Lifecycle Cost
Development Cost / (75,000)
Setup Cost / 16 Design X $600 X 4 Years / (38,400)
Direct Production Cost / $0.50 X 160,000 cards / (80,000)
Indirect Manufacturing Cost / $50,000 X 4 Years / (200,000)
Customer Service Expense / $0.10 X 160,000 cards / (16,000)
Total Estimated Lifecycle Cost / (409,400)
Estimated life-cycle Profit / 150,600


Colorfull Autocar Company manufactures automobiles. The Red Car Division sells its red cars for $25,000 each to the general public. The red cars have manufacturing costs of $12,500 each for variable and $5,000 each for fixed costs. The division's total fixed manufacturing costs are $25,000,000 at the normal volume of 5,000 units.

The Blue Car Division has been unable to meet the demand for its cars this year. It has offered to buy 1,000 cars from the Red Car Division at the full cost of $17,500. The Red Car Division has excess capacity and the 1,000 units can be produced without interfering with the current outside sales of 5,000. The 6,000 volume is within the division's relevant operating range.

Explain whether the Red Car Division should accept the offer. Support your decision showing all calculations

SUGGESTED ANSWER

Offered Price 17,500

Less : Direct Cost (12,500)

Contribution Per Unit $5,000

By accepting the offer from Blue Car Division, The Red Car Division will enjoy additional contribution of ($5,000 X 1,000) $5,000,000.

The general fixed cost of 25,000,000 (which is currently being apportioned at $5,000 per unit) is irrelevant in decision making because the cost will incur regardless of the decision. Furthermore, by optimizing the utilization of the available resources, Red Division will be able to apportioned the fixed cost over larger number of units. This will reduce the Fixed overhead absorbed by each unit. This in turn will translate to lower total cost per unit and a higher gross profit margin

As such, They should accept the offer.