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:
Chemicals ….. $23,400
Direct labor ….. 9,000
Catalyst ….. 3,600
Overhead ….. 8,000
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 PR1. 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.
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?