A company manufactures two models of a pocket calculator. The basic model sells for ₹5, has a direct material cost of ₹1.25 and requires 0.25 hours of labour time to produce. The other model, the Scientist, sells for: ₹7

Answer 6(a) In view of its scarcity, labour is taken as the limiting factor. The decision on whether to make or buy the component has to be made before it can be decided whether or not to accept the contract. In order to do this the contribution per labour hour for normal production must first be calculated, as the contract will replace some normal production. Particulars Basic Model-I (₹) Scientist Model-2 (₹) Selling Price 5.00 7.50 Materials 1.25 1.63 Labour 1.50 2.25 Contribution 2.25 3.62 Limiting Factor (Direct Labour Hr. P.U.) 0.25 0.375 Contribution per direct Labour hour 9.00 9.65 Therefore, if the company is to make the component it would be better to reduce production of the basic model, in order to accommodate the special order. The company should now compare the costs of making or buying the component. An opportunity cost arises due to the lost contribution on the basic model. Special contract manufacture of component Particulars Amount (₹) Material 1,000 Labour (₹6 * 150 hours) 900 Opportunity cost (150 hours * ₹9) 1,350 Total 3,250 Since this is higher than the bought-in price of ₹2,500 the company would be advised to buy the component from the supplier if they accept the contract. The contract can now be evaluated: Contract Contribution Particulars Amount (₹) Amount (₹) Sales Revenue 35,000 Materials 9,000 Component 2,500 Labour (1200@ ₹6) 7,200 18,700 Contribution (A) 16,300 Total Labour Hours (B) 1200 Contribution per direct labour hour (A)/(B) ₹13.58 Since the contribution is higher than either of the existing products, the company should accept the contract assuming this would not prejudice the market for existing products. As the customer is overseas this seems a reasonable assumption. Because the contribution is higher for the Scientist model it would be wise to reduce production of the basic model. However, the hours spent on producing the basic model per month are 8,000 units * 0.25 hours = 2,000, and so the contract would displace more than a fortnight's production of the basic model. The recommendation assumes that this can be done without harming long-term sales of the basic model.