Paineze Drug Corporation buys three chemicals that are processed to produce two types of analgesic used as ingredients for popular over-the-counter drugs. The purchased chemicals are blended for two to three hours and then heated for 15 minutes. The results of the process are two separate analgesics, kyrtec and mobax, which are sent to a drying room until their moisture content is reduced to 6 percent to 8 percent. For every 1,100 kilograms of chemicals used, 500 kilograms of kyrtec and 500 kilograms of mobax are produced. After drying, kyrtec and mobax are sold to companies that process them into their final form. The selling prices are $10 per kilogram for kyrtec and $25 per kilogram for mobax. The total cost to produce 500 kilo- grams of each analgesic is as follows:
Chemicals ..........................$5,500
Direct labour ....................... 3,500
Overhead .......................... 4,500
The analgesics are packaged in 25-kg bags and shipped. The cost of each bag is $0.75. Shipping costs are $0.10 per kilogram. Paineze could process kyrtec further by grinding it into a fine pow- der and then moulding the powder into tablets. The tablets could then be sold directly to retail drugstores as a generic brand. If this route is taken, the revenue received per bottle of tablets would be $3, with 5 bottles produced from every kilogram of kyrtec. The costs of grinding and tableting total $2.50 per kilogram of kyrtec. Bottles cost $0.20 each and are shipped in boxes that hold 25 at a shipping cost of $1.23 per box.
Paineze could also process mobax further by grinding it into a fine powder and then filling caplets with this powder. The caplets could then be sold directly to retail drugstores as a generic brand. If this route is taken, the revenue received per bottle of tablets would be $6, with 5 bottles produced from every kilogram of mobax. The costs of grinding and encapsulating total $5.00 per kilogram of mobax. Bottles cost $0.20 each and are shipped in boxes that hold 25 at a shipping cost of $1.23 per box.
Required:
Write a memo to the CEO of Paineze detailing the optimal path for maximizing profit. (Hint: Should they continue to sell both kyrtec and mobax at the split-off point, process both kyrtec and mobax further, or a combination?). In your analysis to the CEO, be sure to confirm how much incremental profit will result from your recommendation. Recall that Paineze currently sells kyrtec and mobax at the split-off point, and assume that Paineze normally sells 295,000 kilograms each of kyrtec and mobax per year.