I’m not sure if i allocated the cost of the machine correctly. Does that go right into fixed cost like i have it
below in my answer?
Data for the question:
David and his family love root beer. There is an empty area in the current microbrewery facility that could be dedicated to making root beer. As a result, David has been talking with his family about producing and selling a line of specialty root beer. Root beer would be produced using different machinery rather than the existing five beer machines. David’s sister knows someone who is getting out of the soda business and would be willing to sell the used machinery needed to make the root beer for $8,000. Based on market research he has done, David thinks that he could charge $16.50 per case of root beer. Based on the same market research, there is a lot of uncertainty in how many cases of root beer the company could sell. David is less familiar with the root beer market and there is a wide range in sales of specialty root beer in the local groceries. Based on his understanding of the market, he thinks he could sell between 2,500 and 10,000 cases of root beer per year with likely sales of about 5,000 cases.
Root beer could be sold to some of his current distributors. However, soda does not need to be sold through the three-tier system that is required for alcohol sales. Therefore, much of the root beer sales would be directly to upscale groceries such as La Grande Orange Grocery and Pizzeria in Phoenix and Whole Foods and AJ’s Fine Foods with locations throughout Arizona. David could produce the root beer in-house or out-source the production. David has talked with another company who could produce the root beer for TM using David’s recipe and TM could sell it as their brand (this option is referred to as “private label”). It could be purchased from this other company for $13.25 per case. TM would still need to incur some variable handling costs and some minor fixed costs. Alternatively TM could produce the root beer in house. See Exhibit 3 for estimated cost information.
1. Analyzing the sales forecast for root beer, what preliminary course of action do you recommend (in-house or out-source production) and why? Support your recommendations with numbers.
Here’s my answer: (I’m not sure if the $8000 machine cost goes right to ‘direct fixed cost’ in the Alternative 1 below)
David should outsource the making of the root beer since at his lower volume projections he would still turn a profit whereas with owning the equipment he would have a $18,625 loss. Also at his most likely scenario with selling 5,000 cases, hes still making almost double the profit by outsourcing the production. My advice to David would be to outsource production and if volumes increase past 5,000 he should re-analyze his situation and based on volume he might purchase a machine and produce in-house in the future but to start out he should outsource the production.