Product mix decision

A manufacturing Company may be faced with a decision about whether to change the product
mix in its process so as to produce a greater proportion of one product and less of another e.g.
if a process produces product X and Y in the ratio of 2:1, it may be possible to change the ratio
to 3:2 but such a decision requires consideration of the relevant costs and relevant revenue of
the change.

>>> Illustration

XYZ Ltd produces 2 joint products P&Q in the ratio of 2:1. After the split off point the products
can be sold for industrial use and/or taken to mixing plant for blending and refining. The
following information is given for a specific week:

Sales P Q
2000 litres 1000litres
Price per litre $35 $60
Sales revenue $70,000 $60,000
Joint process cost $30,000 $15,000
Blending & refining $25,000 $25000
Other separable cost $5,000 $1000
60,000 41,000
Profits $10,000 $19000

Joint process costs (which are allocated on volume) are 75% fixed and 25%variable, whereas
the mixing plants costs are 40% fixed and 60% variable. There are only 40 hrs available in the
mixing plant (usually 30hrs are taken up to processing of product P&Q equally and 10 hrs are
used for other work that generates a contribution of $2000 per hr)
It has been suggested that it might be possible to change the mix of the joint
process to 3:2 for P&Q respectively at a cost of $5 for each additional litre of Q
produced by the process.
Required
Advise the Co. on whether to change the mix
Solution

Proposed mix
P = 3/5 x 3000 = 1800 litres
Q =2/5 x 3000 = 1200 litres

Cost Benefit Analysis

Incremental revenue of Q 200@ $60 12000
loss of revenue of P 200 @$35 7000
Net incremental revenue 5,000
Incremental Costs
Joint processing costs 200@ $ 5 1000
Blending and refining

TEXT
Extra costs of Q 25000/1000*.6*200 3000
Savings of P 25000/2000*.6*200 (1500) 1500
Other separable costs 200(1-2.5) (300)

STUDY
Opportunity costs (3-1.5)x2000 3000 (5700)
Net Incremental profit (200)

Decision

The Company should not change the mix because it results in an incremental loss of
$200.

3.8 PRICING DECISIONS