Question

Donellan Company produces a special gear used in automatic transmissions. Each gear sells for $30, and the company sells approximately 500,000 gears each year. Unit cost data for the year follows:

Direct material			$9.00
Direct labor			8.00
Other costs:	Variable		Fixed
Manufacturing	$3.00		$7.00
Distribution	5.00		3.00

Donellan has received an offer from a foreign manufacturer to purchase 25,000 gears. Domestic sales would be unaffected by this transaction. If the offer is accepted, variable distribution costs will increase $1.00 per gear for insurance, shipping, and import duties. The relevant unit cost to a pricing decision on this offer is:

a. $24.00.

b. $20.00.

c. $26.00.

d. $18.00.

Answer 1

• Relevant cost = Variable costs to be incurred + any avoidable fixed cost + any contribution margin lost due to acceptance of offer.
• There is no avoidable fixed cost mentioned.
• Its also been mentioned that normal sales would be unaffected, hence there will be no ‘contribution margin lost’.
• The relevant cost would be:

Direct Material	$                     9.00
Direct Labor	$                     8.00
Manufacturing [Variable]	$                     3.00
Distribution [Variable $ 5 + $ 1]	$                     6.00
Relevant cost per unit	$                   26.00

• Correct Answer = Option ‘C’ $ 26.00