Femino enterprise produces products Z that it sells for R63 each. The cost of producing and selling 120 000 units of products Z are estimated as follows:

Question

Variable cost per unit
Direct material R15.00
Direct Labour R9.00
Factory overhead R6.00
Selling and administrative expenses R7.50
Total R37.50
Fixed cost:
Factory overhead R1 600 000
Selling and administration expenses R 600 000
To date, this year, 90 000 units have been produced and sold. An additional 22 500
units are expected to be sold on the domestic market during the remainder of the year.
Femino Enterprises received an offer from Zambesi Traders for 6 000 units of product
Z at R42 each. Zambesi Traders will market the product in Zambia under its own brand
name, and no additional selling and administrative expenses associated with the sale
will be incurred by Femino Enterprises. The sale to Zambesi Traders is not expected
to affect domestic sales of product Z and the additional units could be produced during
the current year using excess capacity.
Required
Should the proposal be accepted? Motivate your answer (10 marks)
2.2
Dubai Ltd needs a component for one of its products. It can subcontract production of
the component to a subcontractor who can provide the component at R20 each. Dubai
Ltd can produce the component internally for total variable costs of R15 per
component.
Dubai Ltd has no spare capacity, so it can only produce the component internally by
reducing its output of another of its products. While it is making each component it will
lose contributions (contribution margin) of R12 from the other product.
Required
2.1 Should the component be subcontracted or produced internally? Motivate your
answer. (10marks)
2.2 Name two problems Dubai Ltd may experience if it decides to subcontract any of
its components. (5 marks)

Answer 1

2.1 Should the Proposal from Zambesi Traders be Accepted?

To determine whether Femino Enterprises should accept the proposal from Zambesi Traders, we will analyze the financial implications of selling the extra 6,000 units at the offered price of R42 each.

Relevant Costs:

1. Variable Costs (per unit):

   • Direct Material: R15.00
   • Direct Labour: R9.00
   • Factory Overhead: R6.00
   • Selling and Administrative Expenses: R7.50
   • Total Variable Cost: R37.50 (this includes Selling and Administrative which is not relevant here since it won’t incur for this sale)

2. Relevant Variable Costs for the new sale:

   • Direct Material: R15.00
   • Direct Labour: R9.00
   • Factory Overhead: R6.00
   • Total Relevant Variable Cost: R15.00 + R9.00 + R6.00 = R30.00

Revenue from the offer:

• Selling Price per unit = R42.00
• For 6,000 units: 6,000 units * R42.00 = R252,000

Total Relevant Costs for the offer:

• For 6,000 units: 6,000 units * R30.00 = R180,000

Contribution Margin from the sale:

• Contribution = Revenue - Relevant Costs
• Contribution = R252,000 - R180,000
• Contribution = R72,000

Final Decision: Since the proposal generates a positive contribution margin of R72,000, Femino Enterprises should accept the proposal from Zambesi Traders. This sale utilizes excess capacity and does not affect domestic sales, thus improving overall profitability.

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2.2 Should Dubai Ltd Subcontract the Component or Produce Internally?

To evaluate whether Dubai Ltd should subcontract or produce the component internally, we again look at the costs involved.

Costs if Dubai Ltd Produces Internally:

• Total Variable Cost per component: R15.00
• Contribution lost from other product per component: R12.00
• Total cost if produced internally (including lost contribution): R15.00 + R12.00 = R27.00

Cost if Subcontracted:

• Subcontractor cost per component: R20.00

Comparison:

• Self-production Total Cost: R27.00 (including opportunity cost)
• Subcontracting Total Cost: R20.00

Decision: Since subcontracting the component costs R20.00, which is less than the R27.00 it costs to produce it internally (including lost contributions), Dubai Ltd should subcontract the component.

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2.3 Problems Dubai Ltd May Experience if it Decides to Subcontract:

1. Quality Control Issues: By outsourcing, Dubai Ltd may not have the same oversight on quality as it does in-house. Poor quality components delivered by the subcontractor could harm Dubai Ltd's product reputation and lead to increased return rates and customer dissatisfaction.

2. Dependency on Third-Party Suppliers: Subcontracting can create a reliance on external suppliers, which may lead to issues if the subcontractor fails to deliver on time or if there are supply chain disruptions. This dependency can threaten production schedules and disrupt the overall business operations.

In summary, while subcontracting might provide immediate cost savings, it is crucial to consider the long-term implications, including quality and supplier reliability.