Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 34,000 Rets per year. Costs associated with this level of production and sales are given below:

  

	Unit			Total
Direct materials	$	25		$	850,000
Direct labor		6			204,000
Variable manufacturing overhead		3			102,000
Fixed manufacturing overhead		5			170,000
Variable selling expense		2			68,000
Fixed selling expense		6			204,000
Total cost	$	47		$	1,598,000

   

The Rets normally sell for $52 each. Fixed manufacturing overhead is constant at $170,000 per year within the range of 29,000 through 34,000 Rets per year.

  

Required:
1.	Assume that due to a recession, Polaski Company expects to sell only 29,000 Rets through regular channels next year. A large retail chain has offered to purchase 5,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 5,000 units. This machine would cost $10,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

     

2.

Refer to the original data. Assume again that Polaski Company expects to sell only 29,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 5,000 Rets. The Army would pay a fixed fee of $2.00 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

     

3.	Assume the same situation as that described in (2) above, except that the company expects to sell 34,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 5,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 5,000 Rets were sold through regular channels?

Answer 1

1)	New contribution margin
	Selling price		52*(1-.16)			43.68
	less :Variable expense
	Direct materials				25
	Direct labor				6
	variable manufacturing overhead				3
	variable selling expense			(2*25%)	0.5
	total variable expense				34.5	-34.5
	New contribution margin					9.18
	total contribution margin			(5000*9.18)		45900
	less :cost of machine					-10,000
	Net income					35900
	financail advantage			35,900
2)	Fixed fee				2
	Fixed manufacturing overhead reimbursed				5
	total				7
	total contribution		5000*7		35000
	financial advantage		35,000
	(note though VMOH is also reimbursed ,it is not considered as the same amount
	will be incurred in production also)
3)	original contribution margin per unit
	Selling price					52
	less :Variable expense
	Direct materials				25
	Direct labor				6
	variable manufacturing overhead				3
	variable selling expense				2
	total variable expense				36	-36
	New contribution margin					16
	contribution lost		(5000*16)			-80000
	income from Army order					35,000
	Net loss					-45000
	Net profit will decrease by			-45000
	financial disadvantage			45,000	answer