Alternative Course of Action
When deciding between alternative courses of action, it should be kept in mind that whatever course of action is adopted, certain fixed expenses will remain unaffected. Therefore, the effect of alternative course of action depends upon the marginal cost. The course of action which yields the greatest contribution is the most profitable to be followed by the management.
Illustration
The following are the details pertaining to Sundaram Manufacturing Company:
Average output per week = 72,000 units
Number of employees worked = 240
Sales value of output = Rs.9,00,000
Contribution made by output towards fixed cost and profit = Rs.3,60,000
The management of the company is planning to introduce a new proposal. As per the new proposal, the company purchases an automated machine at a cost of Rs.2,40,000. With this machine, the company can operate 180 workers with an increase in output per individual employee by 60%. For this, the management is planning to offer 1% increase in piece rate at Re.1 per unit of every 2% increase in individual output. To sell the extra units produced the company has to reduce the selling price by 4%. You are required to advise the company about the acceptance of the proposal.
Solution
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Marginal cost
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= S - C = Rs.9,00,000 - Rs.3,60,000 = Rs.5,40,000
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Marginal cost per unit
without including wages = (5,40,000 - 72,000)/72,000 = Rs.6.50
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Present output per employee = 72,000/240 = 300 units
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Expected output per employee = 480 (300 + 60% of 300)
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Total output for 180 employees = 86,400 units
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Present rate of wage Re.1 per unit.
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Proposed rate = 1.30 per unit.
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Present selling price = 12.5 per unit
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As per proposal = 12 per unit (12.5 - 4% of 12.5)
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Viability of the proposal:
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Sales = 86,400 units @ Rs.12 per unit = 10,36,800
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Less: Marginal Cost
= (6.50 + 1.30)86,400
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= 6,73,920
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Contribution = S -V
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= 3,62,880
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Less: Present Contribution
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= 3,60,000
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Increase in contribution
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= Rs.2,880 per week.
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The proposal can be taken up as it increases the contribution.
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