Relevant Costing

A company makes a product which requires two sequential operations (Operation 1 and Operation 2) on the same machine. The machine is fully utilised. Material costs $12 per unit.

Instead of carrying out Operation 1, the company could buy in components, for $15 per unit. This would allow production to be increased because the machine has to deal with only Operation 2.

Operation 1 takes 0.25 hours of machine time and Operation 2 takes 0.5 hours of machine time. Labour and variable overheads are incurred at a rate of $16/machine hour and the finished products sell for $30 per unit.

This question I Got from ACCA Technical Article and found the answer as follows :

Production volume – this can increase by 50% because currently each item takes 0.5 hours in Operation 2, but 0.25 hours per unit will be released by Operation 1 which now will not be needed.

Assuming output is 1,000 units, the following would occur (ignoring labour and variable overheads which we know to be constant):

Increase in revenue (50% extra could be produced) = 500 additional units x $30 = $15,000
Increase in costs (material/buy-in costs only) = (1,500 x $15) – (1,000 x $12) = $10,500
Therefore, it is worth buying in as incremental revenue exceeds incremental costs.

Question is that How the Production volume increase by 50% ?
Because operation 1 takes 0.25 Hours, how they computed 50% and made incremental revenue 500 units ?