Question

Williams Company, located in southern Wisconsin, manufactures a variety of industrial valves and pipe fittings that are sold to customers in nearby states. Currently, the company is operating at about 70% capacity and is earning a satisfactory return on investment. Glasgow Industries Ltd. of Scotland has approached management with an offer to buy 120,000 units of a pressure valve. Glasgow Industries manufactures a valve that is almost identical to Williams’ pressure valve; however, a fire in Glasgow Industries’ valve plant has shut down its manufacturing operations. Glasgow needs the 120,000 valves over the next 4 months to meet commitments to its regular customers; the company is prepared to pay $21 each for the valves. Williams’s product cost for the pressure valve, based on current attainable standards, follows: Direct materials $ 6 Direct labor (0.5 hour per valve) 8 Manufacturing overhead (1/3 variable) 9 Total manufacturing cost $ 23 Additional costs incurred in connection with sales of the pressure valve are sales commissions of 5% and freight expense of $1 per unit. However, the company does not pay sales commissions on special orders that come directly to management. Freight expense will be paid by Glasgow. In determining selling prices, Williams adds a 40% markup to product cost. This provides a $32 suggested selling price for the pressure valve, rounded to the nearest whole dollar. The marketing department, however, has set the current selling price at $30 to maintain market share. Production management believes that it can handle the Glasgow Industries order without disrupting its scheduled production. The order would, however, require additional fixed factory overhead of $12,000 per month in the form of supervision and clerical costs. If management accepts the order, Williams will manufacture and ship 30,000 pressure valves to Glasgow Industries each month for the next 4 months. Shipments will be made in weekly consignments, FOB shipping point. Required: 1. Determine how many additional direct labor hours (DLHs) will be required each month to fill the Glasgow order. 2. Prepare an analysis showing the impact on operating income of accepting the Glasgow order. 3. Calculate the minimum unit price that Williams’ management could accept for the Glasgow order without reducing operating income. 4. To prove your answer to Requirement 3, use the Goal Seek function in Excel to calculate the minimum unit selling price for the special sales order. 5. Suppose now that if the Glasgow order were accepted, sales of 5,000 units per month to regular customers would be precluded (at a selling price of $30 per unit). All other facts are as given in this problem. What is the revised breakeven selling price per unit for the Glasgow special sales order?

Answer 1

1.Determine how many additional direct labor hours (DLHs) will be required each month to fill the Glasgow order

Number of valves = 120,000

Hours required per valve = 0.5

Additional Direct Labour Hours required = 120,000*0.5 = 60,000

2. Prepare an analysis showing the impact on operating income of accepting the Glasgow order.

Sales 120,000*21	2,520,000
Less: relevant Costs
Direct Material 120,000*6	720,000
Direct Labor 120,000*8	960,000
Variable manufacturing overhead 120,000*3	360,000
Total Variable Manufacturing Cost	2,040,000
Additional Fixed factory Overhead 12,000*4	48,000
Operating Income from the Order	432,000

Hence, the operating income will increase by $432,000

3.Calculate the minimum unit price that Williams’ management could accept for the Glasgow order without reducing operating income

Minimum Unit Price will be such that has no profit no loss

i.e. (2,040,000+48,000)/120,000 = $17.4

5. Suppose now that if the Glasgow order were accepted, sales of 5,000 units per month to regular customers would be precluded (at a selling price of $30 per unit). All other facts are as given in this problem. What is the revised breakeven selling price per unit for the Glasgow special sales order?

Contribution from Regular Sales:

Selling Price	$30
Direct Material	6
Direct Labor	8
Variable manufacturing overheads	3
Commission	1.5
Freight	1
Total Variable Cost	19.5
Contribution per unit	$10.5

Break-even Selling Price = (Cost incurred + Contribution lost)/Number of units

= (2,040,000+48,000+ 10.5*20,000)/120,000

= $19.15