# Pharmaco Corporation buys three chemicals that are processed to produce two popular ingredients for liquid pain relievers. The three chemicals are in liquid form. The purchased chemicals are blended for two to three hours and then heated for 15 minutes. The results of the process are two separate ingredients, PR1 and PR2. For every 4,300 gallons of chemicals used, 2,000 gallons of each pain reliever are produced. The pain relievers are sold to companies that process them into their final form. The selling prices are $34 per gallon for PR1 and$45 per gallon for PR2. The costs to produce one batch (containing 2,000 gallons of each chemical) are as follows: The pain relievers are bottled in five-gallon plastic containers and shipped. The cost of each container is $2.10. The costs of shipping are$0.50 per container. Pharmaco Corporation could process PR1 further by mixing it with inert powders and flavoring to form tablets. The tablets can be sold directly to retail drug stores as a generic brand. If this route is taken, the revenue received per case of tablets would be $13.50, with eight cases produced by every gallon of PR 1. The costs of processing into tablets total$11.00 per gallon of PR1. Packaging costs $5.16 per case. Shipping costs are$1.68 per case. Required: 1. Should Pharmaco sell PR1 at split-off, or should PR1 be processed and sold as tablets? 2. If Pharmaco normally sells 26,000 gallons of PR1 per year, what will be the difference in profits if PR1 is processed further?

### Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

Chapter
Section

### Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
Chapter 17, Problem 29P
Textbook Problem
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## Pharmaco Corporation buys three chemicals that are processed to produce two popular ingredients for liquid pain relievers. The three chemicals are in liquid form. The purchased chemicals are blended for two to three hours and then heated for 15 minutes. The results of the process are two separate ingredients, PR1 and PR2. For every 4,300 gallons of chemicals used, 2,000 gallons of each pain reliever are produced. The pain relievers are sold to companies that process them into their final form. The selling prices are $34 per gallon for PR1 and$45 per gallon for PR2. The costs to produce one batch (containing 2,000 gallons of each chemical) are as follows:The pain relievers are bottled in five-gallon plastic containers and shipped. The cost of each container is $2.10. The costs of shipping are$0.50 per container.Pharmaco Corporation could process PR1 further by mixing it with inert powders and flavoring to form tablets. The tablets can be sold directly to retail drug stores as a generic brand. If this route is taken, the revenue received per case of tablets would be $13.50, with eight cases produced by every gallon of PR 1. The costs of processing into tablets total$11.00 per gallon of PR1. Packaging costs $5.16 per case. Shipping costs are$1.68 per case.Required: 1. Should Pharmaco sell PR1 at split-off, or should PR1 be processed and sold as tablets? 2. If Pharmaco normally sells 26,000 gallons of PR1 per year, what will be the difference in profits if PR1 is processed further?

1.

To determine

Indicate whether company P should sell the PR 1 at split-off or processed and sold as tablets.

### Explanation of Solution

Tactical decision making: Tactical decision making is a process in which the company can choose the correct alternative based on the profitability. In tactical decision making, offer price of a product is compared with the normal selling price and offer price less than the normal selling price of product is considered as the idle capacity for decision making.

Indicate whether company P should sell the PR 1 at split-off or processed and sold as tablets as follows:

 Particulars Process further (B) Sell at spilt-off (C) Differential amount for further process (B−C) Revenues (1) $216,000$68,000 $148,000 Less: Containers (2)$0 ($840)$840 Shipping (3) ($26,880)$200 ($26,680) Processing (4) ($22,000) $0 ($22,000) Packaging (5) ($82,560)$0 ($82,560) Net income$84,560 $66,960$17,600

Table (1)

In this case, company P should process the pain reliever further because the net income from further processing ($84,650) is more than the spilt-off ($66,960).

Working note (1):

Calculate the value of revenues.

Revenue for further process:

Revenue =[ Number of gallone produced ×Number of cases per gallon PR1×Revenue per case]=2,000 gallon×8 cases×$13.50 per case=$216,000

Revenue for spilt off:

Revenue = [Number of gallon produced ×Selling price per gallon]=2,000 gallon×$34=$68,000

Working note (2):

Calculate the cost of containers.

Cost of containers = [Number of gallon producedNumber of container ×Cost per container]=2,0005×\$2

2.

To determine

State the difference in the profits; assume that PR1 is processed further.

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