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11-37 Solution Opportunity Costs

Bajaj produces Rosebo units that have a contribution margin of Rs. 90 per unit. The opportunity cost of producing 2,000 units of Orangebo instead is Rs. 1,80,000, which is the contribution margin lost from not producing the 2,000 Rosebo units. Purchasing the 2,000 Rosebo units from Reliable and manufacturing the 2,000 Orangebo units would give Bajaj a total contribution margin of Rs. 1,60,000. Since Rs. 1,80,000 is more, Bajaj should refuse the offers from Royal and Reliable.

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Sakshi Verma
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55 views

11-37 Solution Opportunity Costs

Bajaj produces Rosebo units that have a contribution margin of Rs. 90 per unit. The opportunity cost of producing 2,000 units of Orangebo instead is Rs. 1,80,000, which is the contribution margin lost from not producing the 2,000 Rosebo units. Purchasing the 2,000 Rosebo units from Reliable and manufacturing the 2,000 Orangebo units would give Bajaj a total contribution margin of Rs. 1,60,000. Since Rs. 1,80,000 is more, Bajaj should refuse the offers from Royal and Reliable.

Uploaded by

Sakshi Verma
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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11-37

Solution
Opportunity costs
1. The opportunity cost to Bajaj of producing the 2,000 units of Orangebo is the contribution margin lost on the
2,000 units of Rosebo that would have to be forgone, as computed below:
Selling price Rs 200
Direct materials Rs 20
Direct manufacturing labor 30
Variable manufacturing overhead 20
Variable marketing costs 40 110
Contribution margin per unit Rs 90
Contribution margin for 2,000 units Rs 1,80,000

The opportunity cost is Rs 1,80,000. Opportunity cost is the maximum contribution to operating income that
is forgone (rejected) by not using a limited resource in its next-best alternative use.

2. Contribution margin from manufacturing 2,000 units of Orangebo and purchasing 2,000 units of Rosebo from
Reliable is Rs 1,60,000, as follows:
Manufacture Orangebo Purchase Rosebo Total
Selling price Rs 150 Rs 200
Variable costs per unit:
Purchase costs -- 140
Direct materials 20
Direct manufacturing labor 30
Variable manufacturing costs 20
Variable marketing overhead 20 40
Variable costs per unit 90 180
Contribution margin per unit Rs 60 Rs 20

Total Contribution Margin Rs. 1,20,000 Rs. 40,000 Rs. 1,60,000

As calculated in requirement 1, Bajaj's contribution margin from continuing to manufacture 2,000 units of
Rosebo is Rs 1,80,000. Accepting the Royal Company and Reliable offer will cost Bajaj Rs 20,000 (Rs 1,60,000
Rs 1,80,000). Hence, Bajaj should refuse the Royal Company and Reliable Corporation's offers.

3. The minimum price would be Rs 90, the sum of the incremental costs as computed in requirement 2. This
follows because, if Bajaj has surplus capacity, the opportunity cost = Rs 0. For the short-run decision of whether to
accept Orangebo's offer, fixed costs of Bajaj are irrelevant. Only the incremental costs need to be covered for it to
be worthwhile for Bajaj to accept the Orangebo offer.

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