Miller Company produces speakers for home stereo units. The speakers are sold to retail stores for $30. Manufacturing and other costs are as follows: The variable distribution costs are for transportation to the retail stores. The current production and sales volume is 20,000 per year. Capacity is 25,000 units per year.
A Tennessee manufacturing firm has offered a one-year contract to supply speakers at a cost of $17.00 per unit. If Miller Company accepts the offer, it will be able to rent unused space to an outside firm for $18,000 per year. All other information remains the same as the original data. What is the effect on profits if Miller Company buys from the Tennessee firm?

Question

Miller Company produces speakers for home stereo units. The speakers are sold to retail stores for $30. Manufacturing and other costs are as follows:  The variable distribution costs are for transportation to the retail stores. The current production and sales volume is 20,000 per year. Capacity is 25,000 units per year.
A Tennessee manufacturing firm has offered a one-year contract to supply speakers at a cost of $17.00 per unit. If Miller Company accepts the offer, it will be able to rent unused space to an outside firm for $18,000 per year. All other information remains the same as the original data. What is the effect on profits if Miller Company buys from the Tennessee firm?

Quizplus · Accepted Answer

First, let's calculate the current profit:
Revenue = 20,000 x $30 = $600,000
Variable costs = ($9 + $3 + $1) x 20,000 = $260,000
Fixed costs = $220,000
Profit = Revenue - Variable costs - Fixed costs = $600,000 - $260,000 - $220,000 = $120,000

If Miller Company accepts the Tennessee firm's offer, the cost per unit will be $17 instead of $13. Therefore, the new profit will be:

Revenue = 20,000 x $30 = $600,000
Variable costs = ($9 + $3 + $1 + $17) x 20,000 = $600,000
Fixed costs = $38,000 ($20,000 rent + $18,000 outside firm)
Profit = Revenue - Variable costs - Fixed costs = $600,000 - $600,000 - $38,000 = -$38,000

As we can see, Miller Company will have a loss of $38,000 if it accepts the Tennessee firm's offer. This is because the cost per unit is higher than the selling price. Therefore, it is not the best choice to accept this offer. The best choice is to continue producing the speakers at a cost of $13 per unit and selling them for $30 per unit, which gives Miller Company a profit of $120,000.

Miller Company Produces Speakers for Home Stereo Units