Question

Relling Corporation manufactures a drink bottle, model CL24. During 2020, Reling produced 250,000 bottles at a total cost of $900,000. Young Corporation has offered to supply as marry bottles as Relling wants at a cost of $3.50 per bottle. Relling anticipates needing 263,000 bottles each year for the next few years. Read the requirements per bottle is Requirement la. What is the average cost of manufacturing a drink bottle in 2020? How does it compare to Young's offer? The average cost of 36 greater than Young's offer. Requirement lb. Can Rolling use the answer in requirement la to determine the cost of manufacturing 263,000 drink bottles? Explain Relling cannot take the average manufacturing cost in 2020 to determine the total cost of manufacturing 263,000 drink bottles. The reason is that some of the total costs are fixed costs and some are variable costs

Answer 1

Solution

Relling Corporation

1. Average cost to manufacture -

1a. Average cost of manufacture of a drink bottle = total cost to manufacture/number of units

= $900,000/250,000 = $3.60

The average cost of $3.60 per bottle is higher than Young’s offer.

1b. Relling Cannot take the average manufacture cost in 2020 to determine the total cost of manufacturing 263,000 drink bottles. The reason is that the total cost of $900,000 comprise variable cost and fixed cost. The variable cost would change with the level of output, while the fixed cost would remain the same regardless of the output. Hence, the variable portion of the total cost increases and hence the average cost per bottle also changes.

2. Estimation of the cost to manufacture 263,000 bottles –

Using the given regression equation, y = $438,000 + $2.00X

Cost to manufacture 263,000 bottles, y = $438,000 + $2 x 263,000 bottles

Y = 438,000 + 526,000 = $964,000

Hence, cost to manufacture 263,000 bottles = $964,000

Cost to purchase the bottles 263,000 x $3.50 = $920,500

It will cost $43,500 less to purchase the bottles rather than manufacture them in-house.

However, for decision making purposes, the fixed portion of $438,000 is not considered and only the variable cost to manufacture the bottle, $2 is relevant.

So, on comparison the purchase price of $3.50 is higher than the variable manufacture cost of $2. Hence, considering this analysis the cost to manufacture is less than the cost to purchase the bottles.

3. Other information that is needed –

A. Does the slope of regression line indicates that a strong relationship exists between manufacturing costs and the number of drink bottles produced.

B. Is the relationship between total manufacturing costs and the quantity of drink bottles economically plausible.

C. How good is the goodness of fit? That is, how well does the estimated line fit the data.