Managerial accounting question

Question

Major Mills is a large manufacturer of breakfast cereal. One of its most popular products is Choco-Bombs, which sells at wholesale for $50/case. The cost to produce is $36.30 per case, as follows: Ingredients, $8.40; Packaging, $4.70; Labor, $3.20; Overhead, $20 (30% variable). A large grocery retailer has approached Major Mills with a proposal to create a house-brand version of Choco-Bombs. The retailer offers to purchase 10,000 cases per month of the house brand for one year, after which the contract could be renewed. The retailer will purchase the house brand for $32/case. A slight change in the recipe would reduce ingredients cost by 40 cents per case. Packaging cost would increase by 10 cents per case because of a new ink required. There would be an initial setup cost of $15,000. Because Major Mills has excess capacity of only 9,000 cases per month on the production line, they would lose 1,000 cases per month of sales of Choco-Bombs.

 

a. Would accepting the retailer’s offer be profitable for Major Mills? b. What other factors should be considered in deciding whether to accept the offer?

Answer 1

Please see below workings. If anything is not clear, I would be happy to jump on a tutoring session to clarify the concepts in this topic.

Here's a breakdown of the cost components specifically focusing on the variable costs:

Ingredients Cost per Case: Reduced from $8.40 to $8.00.

Packaging Cost per Case: Increased from $4.70 to $4.80.

Labor Cost per Case: Unchanged at $3.20.

Variable Overhead Cost per Case: Unchanged at $6.00.

Total Variable Cost per Case for House Brand:

Ingredients: $8.00

Packaging: $4.80

Labor: $3.20

Variable Overhead: $6.00

Total Variable Cost per Case: $8.00 + $4.80 + $3.20 + $6.00 = $22.00

Profits per Case for each Product

Choco-Bombs (Original Product):

Revenue per Case: $50.00

Variable Cost per Case: $22.30

Variable Profit per Case: $50.00 - $22.30 = $27.70

House Brand:

Revenue per Case: $32.00

Variable Cost per Case: $22.00

Variable Profit per Case: $32.00 - $22.00 = $10.00

Monthly Financial Impact:

Profit from New Production of House Brand:

Profit from House Brand: 10,000 cases × $10.00 = $100,000

Loss from Reduced Sales of Choco-Bombs:

Lost Profit from Choco-Bombs: 1,000 cases × $27.70 = $27,700

Net Monthly Profit Impact:

Net Profit Impact: $100,000 (profit from house brand) - $27,700 (loss from Choco-Bombs) = $72,300 net increase

Part B - Factors to Consider

1. Brand Image and Market Position: Producing a lower-cost, house-brand product could affect the perceived quality of Major Mills’ own brand.
2. Contract Renewal and Volume Guarantees: The contract is for one year with a possibility of renewal. Major Mills should consider the likelihood of contract renewal and potential adjustments in terms and pricing.
3. Capacity and Long-Term Strategic Goals: Utilizing the existing excess capacity for this contract limits the ability to use that capacity for potentially more profitable or strategic opportunities.
4. Production and Supply Chain Impact: The adjustment in ingredient and packaging could have implications on supply chain relationships and production efficiency.