- 20 Marks
MA – Nov 2015 – L2 – Q3 – Decision making techniques | Relevant cost and revenue
Analyze whether to discontinue Double beds and whether to accept a new order for all bed sizes.
Question
Obonku Limited produces Single, Double, and King-size beds for sale to hotels in West Africa. Its manufacturing plant is located in Tema and is currently operating at 100% capacity. Below is the annual output and sales for each product and the associated costs:
| Product | Single bed | Double bed | King Size bed |
|---|---|---|---|
| Units sold | 5,000 units | 3,500 units | 4,000 units |
| Sales (GHS) | 2,500,000 | 2,800,000 | 3,800,000 |
| Costs: | |||
| Material cost | 750,000 | 1,400,000 | 1,520,000 |
| Labour costs | 600,000 | 1,050,000 | 1,200,000 |
| Manufacturing O’head | 200,000 | 650,000 | 300,000 |
| Administrative cost | 200,000 | 100,000 | 200,000 |
| Total cost | 1,750,000 | 3,200,000 | 3,220,000 |
| Profit/Loss | 750,000 | (400,000) | 580,000 |
The Director of Obonku is of the view that the Double bed product line is not doing well and should not be produced any longer. The following additional information has been provided:
- 40% of the labor cost for all bed types are fixed costs.
- 50% of the manufacturing overhead is variable for all products.
- 80% of the administrative cost is fixed.
Alom Hotel Limited, situated in Elmina, has requested 80 units of each bed and is ready to procure them at the current prices. Obonku Ltd can only produce more if they increase production capacity in the short term at an additional cost of GHS 80,000.
Assuming that costs and prices remain the same, you are required to:
a) Advise whether the company should shut down the production of Double beds. (10 marks)
b) Should the company accept the new order assuming Double beds will still be produced? (10 marks)
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