A company is currently manufacturing at only 60 per cent of full practical capacity, in each of its two production departments, due to a reduction in market share. The company is seeking to launch a new product which it is hoped will recover some lost sales.
The estimated direct costs of the new product, Product X, are to be established from the following information:
Direct materials:
Every 100 units of the product will require 30 kilos net of Material A. Losses of 10 per cent of materials input are to be expected. Material
A costs £5.40 per kilo before discount. A quantity discount of 5 per
cent is given on all purchases if the monthly purchase quantity
exceeds 25 000 kilos. Other materials are expected to cost £1.34
per unit of Product X.
Direct labour (per hundred units):
Department 1: 40 hours at £12.00 per hour.
Department 2: 15 hours at £13.00 per hour.
Separate overhead absorption rates are established for each production department. Department 1 overheads are absorbed at 130 per cent of direct wages, which is based upon the expected overhead costs and usage of capacity if Product X is launched. The rate in Department 2 is to be established as a rate per direct labour hour also based on expected usage of capacity. The following annual figures for Department 2 are based on full practical capacity:
Overhead .....................................£5 424 000
Direct labour hours.......................... 2 200 000
Variable overheads in Department 1 are assessed at 40 per cent of direct wages and in Department 2 are £1 980 000 (at full practical capacity).
Non-production overheads are estimated as follows (per unit of Product X):
Variable ...............................£0.70
Fixed ..................................£1.95
The selling price for Product X is expected to be £16 per unit, with annual sales of 2 400 000 units.
Required:
(a) Determine the estimated cost per unit of Product X.
(b) Comment on the viability of Product X.
(c) Market research indicates that an alternative selling price for Product X could be £15.50 per unit, at which price annual sales would be expected to be 2 900 000 units. Determine, and comment briefly upon, the optimum selling price.