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# Relevant costs

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Like Magic
Part 3

Tracy Turner has decided Like Magic could increase their revenue and profit by also selling their cream in an upscale designer jar at a higher price. Tracy had the jar designed and the staff developed projected data for the upscale jar. The proposed selling price was \$40 per jar, \$5 above the price for the current jar. Demand was projected at 100,000 jars for the coming year. Material expenses would be \$1 per jar greater than for their regular product. The other variable expenses would be the same per unit cost as their current product. Fixed manufacturing overhead expenses would be \$600,000. Fixed marketing expenses for advertising and promotion for the designer jar would cost an additional \$300,000.
Anthony Iococca, VP of Manufacturing, suggested they consider purchasing the jar from an outside manufacturer for the first year. This would let Like Magic test the results of the new jar before investing funds in production equipment. If they bought the jar, Like Magic could avoid \$200,000 in fixed manufacturing overhead. Anthony said idle space is available if they decide to manufacture the new jar. He added that a request had been received from another firm to rent storage facilities from Like Magic for the coming year. If he jar was purchased from another manufacturer, the space could be rented for \$50,000 for the next year.
Tom Turner has received a request for Like Magic to do some contract manufacturing of a cream similar to theirs. He asks the staff to evaluate whether the idle space should be used for contract manufacturing if they purchase the designer jar. You roughly estimate the contract manufacturing would yield a \$60,000 contribution to profit for the coming year.
Tracy asks you to evaluate he profitability of producing and selling the cream in the designer jar. You set up 4 alternatives. Variable expenses if they buy the jar would be:

Materials \$6.00 per unit
Labor \$6.50
Outside purchase Cost \$3.60 per unit

Required:

1. Display all four alternatives
2. Which one is the most profitable?
3. What are the relevant costs among the 3 alternatives of making or buying the jar?
4. If they decide to make it themselves, what is the opportunity cost?
5. Are there any sunk costs?
6. Give an example of an avoidable cost in these alternatives.
7. How would the profitability change if the estimated sales were 200,000 units instead?