Opportunity cost in Further Processing decision

For your reference

21 Sniff Limited (12/07, amended) 36 mins
Sniff Limited 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).
Sniff Limited 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 has 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 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 remaining 800 litres (80%) will be for female customers and 8 litres
of hormone will be added, costing $12,000 per litre. In both cases the adding of the hormone adds to the overall
volume of the product as there is no resulting processing loss.
Sniff Limited has sufficient existing machinery to carry out the test processing.
The new processes will be supervised by one of the more experienced supervisors currently employed by Sniff
Limited. 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. This will be split evenly between the male and female versions of
the product.
Extra 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. Labour is currently fully employed, making the
standard product. New labour with the required skills will not be available at short notice.
Sniff Limited allocates fixed overhead at the rate of $25 per 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 Sniff Limited should consider when making a further processing
decision.
Note: no calculations are required. (3 marks)
(b) Evaluate whether Sniff Limited should experiment with the hormone adding process using the data provided.
Provide a separate assessment and conclusion for the male and the female versions of the product.
(14 marks)
(c) Sniff Limited is considering outsourcing the production of the standard perfume. Outline the main factors it
should consider before making such a decision. (3 marks)
(Total = 20 marks)