Response to the following problem:
Aroma Ltd manufactures and sells its standard perfume by blending a secret formula of aromatic oils with diluted alcohol. The oils are produced by another company following a lengthy process and are very expensive. The standard perfume is highly branded and successfully sold at a price of £39.98 per 100 millilitres (ml).
Aroma Ltd is considering processing some of the perfume further by adding a hormone to appeal to members of the opposite sex. The hormone to be added will be different for the male and female perfumes. Adding hormones to perfumes is not universally accepted as a good idea as some people have health concerns. On the other hand, market research carried out suggests that a premium could be charged for perfume that can ‘promise' the attraction of a suitor.
The market research had cost £3,000.
Data has been prepared for the costs and revenues expected for the following month (a test month) assuming that a part of the company's output will be further processed by adding the hormones.
The output selected for further processing is 1,000 litres, about a tenth of the company's normal monthly output. Of this, 99% is made up of diluted alcohol which costs £20 per litre. The rest is a blend of aromatic oils costing £18,000 per litre. The direct labour required to produce 1,000 litres of the basic perfume before any further processing is 2,000 hours at a cost of £15 per hour.
Of the output selected for further processing, 200 litres (20%) will be for male customers and 2 litres of hormone costing £7,750 per litre will then be added. The hormone required for male customers has yet to be purchased. The remaining 800 litres (80%) will be for female customers and 8 litres of hormone will be added. 10 litres of hormone for female customers have been purchased two weeks ago and it had cost the company £12,000 per litre. The hormone for female customers is used for the company's other product lines. The current purchase price of the hormone for female customers is £13,000 per litre and the resale price is £11,000 per litre. In both cases of further processing for male and female customers, the adding of the hormone adds to the overall volume of the product as there is no resulting processing loss.
Aroma Ltd has sufficient existing machinery to carry out the test processing. The required machinery was bought three years ago at a price of £200,000. It has a useful life of 10 years and has no scrap value.
The new process will be supervised by one of the more experienced supervisors currently employed by Aroma Ltd on a permanent contract. His current annual salary is £35,000 and it is expected that he will spend 10% of his time working on the hormone adding process during the test month. He currently has the capacity to oversee the hormone adding process without compromising his other work commitments. His time on the process will be split evenly between the male and female versions of the product.
Extra direct labour will be required to further process the perfume, with an extra 500 hours for the male version and 700 extra hours for the female version of the hormone- added product. All direct labour is currently fully employed, making the standard product. New labour with the requested skills will not be available at short notice.
Aroma Ltd allocates fixed overhead at the rate of £25 per direct labour hour to all products for the purposes of reporting profits.
The sales prices that could be achieved as a one-off monthly promotion are:
Male version: £75.00 per 100 ml
Female version: £59.50 per 100 ml
Required:
a) Outline the financial and other factors that Aroma Ltd should consider when making the further processing decision.
b) Using relevant costing, evaluate whether Aroma Ltd should experiment with the hormone adding process. Provide a separate assessment and conclusion for the male and the female versions of the product. You need to clearly explain the rationale of your computations.
c) Aroma Ltd is considering outsourcing the production of the standard perfume. Outline the main factors it should consider before making such a decision.