Reference no: EM131120071

1. Outsourcing Decision

St. Vincent Hospital has been hit with a number of complaints about its food service from patients and non-patient cafeteria customers. These complaints, coupled with a very tight local labor market, have prompted the organization to contact Mimi's Food Service (MFS) about the possibility of an outsourcing arrangement. The hospital's business office has provided the following information for food service (to patients, staff, and non-patients customers) for the year just ended:

Cafeteria food sales (to patents, staff, and non-patient cu-stomers) , $1,000,000; Food (materials) costs, $700,000; Direct labor, $200 ,000; Variable overhead, $50,000; Allocated fixed hospital overhead, $100 ,000 (the hospital allocates its fixed overhead to the food service operation based on cafeteria food sales).

Conversations with Mimi's Food Service personnel revealed the following information:

Mimi's Food Service will charge St. Vincent Hospital $14 per day for each patient served. This price has been "marked up" by Mimi's Food Service to reflect the cost of food needed for staff and non-patient customers in the hospital cafeteria.

St. Vincent's 200-bed facility operates throughout the year (365 days) and typically has an average occupancy rate of 85%.

If an outsourcing agreement is reached, 20% of St. Vincent's labor will remain to provide service. Labor is the primary driver for variable overhead. Mimi's Food Service plans to use St. Vincent's facilities for meal preparation (without charge).

Cafeteria food sales (which will be still kept by St. Vincent) are expected to increase by 20% because of prices hikes and improved menu selection.

Required: Should St. Vincent Hospital outsource its food-service operation to Mimi's Food Service? Show your work in the space provided below.

Profit
Keep ______ Outsource
$1,000,000 $1,200,000
Sales
Food Costs/outsourcing costs
Direct Labor
Variable OH
Fixed OH
______________________________________________________________________________________
Profit
What is a differential profit if outsourced? $ _____________________
Recommend Outsourcing? Yes or No

2. Activity-Based Costing

Solar-Tech, Inc. is a manufacturer of solar-powered battery chargers for luxury boat and recreational vehicle manufacturers. At present, the company produces two models: Model ATB which generates 11 watts peak power, and Model Elite which generates 22 watts peak power and also features an ammeter for monitoring charge rate, and a DC to AC inverter.

The firm's pricing policy is to mark up its unit manufacturing costs by 20%. Sales of Model ATB have been disappointing due to strong price competition. Model Elite, however, has been a stunning sales success and has been on backorder since its introduction a year ago. Vinnie "the Weasel" Santucci, the CEO of Solar-Tech, has interpreted this sales pattern as proof that the firm's competitive advantage lies in producing the deluxe model Elite. Accordingly, Vinnie plans to slow production of Model ATB and use the resources which are thereby freed up to produce more units of Model Elite.

Vinnie's father-in-law, Tony "Big Tuna" Bianco, owns 99% of the voting stock of Solar-Tech. He is unsure of both (a) his son-in-law's business acumen, and (b) his daughter's taste in husband. ("She was always infatuated with losers," he is fond of remarking to his business associates .) Mr. Bianco has engaged you as a consultant to examine Solar-Tech's costing system to evaluate whether it can be relied upon to produce accurate product cost data. You have been provided with the following budgeted production and product cost data for the current year:

	Model ATB	Model Elite
# of production runs	10	20
Total units _2_roduced	20,000	10,000
# of components per Model	5	25
Direct materials cost per unit	$50	$150
Direct labor hours per unit _( $20 per DL hour)	2	1

Total production overhead costs $3,800,000

Required: Assume that budgeted and capacity levels are the same for Questions 1-4 below.

1. Solar-Tech's existing cost system uses the overhead rate based on its budgeted total direct labor costs ($) to assign all production overhead costs to products. Calculate the total overhead cost and the unit product cost for Model Elite using Solar-Tech's existing cost system (Not required to compute for Model ATB).
Total OH allocation in $ =
Unit product cost =

2. You have decided to create an ABC system and compiled the following data:

Activity & Cost	Cost Driver
Setup $1,200,000	# of production runs
Production supervision $ 900,000	Total # of direct labor hours
Components handling $1, 700,000	Total # of components handling*
Total overhead costs $3,800,000

* This handling cost is related to BOTH (i) product design costs of each component and (ii) inspection costs required for each production run (i.e., a combination of product and batch activities like in Siemens case). Thus, it is not affected by the number of production units.
Calculate each activity rate, and then calculate the total overhead, the total product cost, and the unit product cost of Model Elite using an ABC system (Not required for Model ATB) . (Round up to a dollar)
Rate X Activity Level = OH
Setup
Production supervision
Components handling
Total OH
Direct materials
Direct labor
Total product cost
Unit product cost

3. Assume that one of the current customers places an order of 100 units of Model Elite (out of a total of 10,000 units).

Each order requires one production run. Compute the total overhead cost for the order of 100 units of Model Elite under the ABC system (Note: refer to your overhead rates in #2 above).
Rate X Activity Level = OH
Setup
Production supervision
Components handling
Total OH

4. Based on your analysis in #1 and #2 above, briefly discuss (in one single sentence) whether you agree with Vinnie that the firm has competitive advantage in the deluxe model Elite and thus, should increase the production of Model Elite.

5. Assume that the practical capacity of production runs (for the setup activity) was 40 although its budgeted level is still 30 runs. Solar-Tech has now increased the capacity level of setup efficiency by 25% from 40 runs to 50 runs.

How much of the setup cost would you allocate to the Model Elite if its costs are allocated by the practical capacity of production runs (after the efficiency increased)? Then, what is the total cost ($) of unused capacity of the setup activity?
Allocation in $:

Total cost of unused capacity:

If you allocate the setup cost by the budgeted level of production runs, what is the total cost of unused capacity of the setup activity?

c. Total cost of unused capacity: