Question

Green Grow Inc. (GGI) manufactures lawn fertilizer. Because of the product’s very high quality, GGI often receives special orders from agricultural research groups. For each type of fertilizer sold, each bag is carefully filled to have the precise mix of components advertised for that type of fertilizer. GGI’s operating capacity is 22,000 one-hundred-pound bags per month, and it currently is selling 20,000 bags manufactured in 20 batches of 1,000 bags each. The firm just received a request for a special order of 5,000 one-hundred-pound bags of fertilizer for $130,000 from APAC, a research organization. The production costs would be the same, but there would be no variable selling costs. Delivery and other packaging and distribution services would cause a one-time $2,500 cost for GGI. The special order would be processed in two batches of 2,500 bags each.Page 447 (No incremental batch-level costs are anticipated. Most of the batch-level costs in this case are short-term fixed costs, such as salaries and depreciation.) The following information is provided about GGI’s current operations: Sales and production cost data for 20,000 bags, per bag: Sales price $40 Variable manufacturing costs 17 Variable selling costs 3 Fixed manufacturing costs 12 Fixed marketing costs 4 No marketing costs would be associated with the special order. Because the order would be used in research and consistency is critical, APAC requires that GGI fill the entire order of 5,000 bags. Required What is the total relevant cost of filling this special sales order, rounded to nearest whole dollar? What would be the change in operating income (to nearest whole dollar) if the special order is accepted? What is the break even selling price per unit for the special sales order (i.e., what is the selling price that would result in a zero effect on operating income)? Round answer to 2 decimal places. Prepare comparative income statements, using the contribution format, for both the current situation and assuming the special order is accepted at the break even price determined in requirement 3. Suppose that after GGI accepts the special order, it finds that unexpected production delays will not allow it to supply all 5,000 units from its own plants and meet the promised delivery date. It can provide the same materials by purchasing them in bulk from a competing firm. The materials would then be packaged in GGI bags to complete the order. GGI knows the competitor’s materials are very good quality, but it cannot be sure that the quality meets its own exacting standards. There is not enough time to carefully test the competitor’s product to determine its quality. What should GGI do? Specifically, discuss ethical and strategic issues associated with the decision.

Answer 1

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Part 1a
Variable manufacturing costs ($17*5,000)			$              85,000
Delivery costs (lump sum)			$                2,500
Opportunity cost (CM on lost sales):
= (sp - var mfg cost - var selling cost) x lost sales			$              60,000
Total Relevant Cost			$            147,500
Part 1b
Offering price, special order			$            130,000
Less: relevant costs:
Variable manufacturing costs ($17*5,000)		$ 85,000
Delivery costs (lump sum)		$    2,500
Opportunity cost (CM on lost sales):
= (sp - var mfg cost - var selling cost) x lost sales		$ 60,000	$            147,500
Income effect of accepting special sales order			$             -17,500
Since there is loss of $17,500, Should not accept the order/
Part 1c
Total Relevant Cost		$147,500
No of Units		5,000
Break Even Selling Price		$    29.50
Part 2
		Current		Current +Special
Sales:
Current		$800,000		$680,000
Special Order		$           -	$            800,000	$147,500	$827,500
Less: Variable Cost
Manufacturing ($17 per unit)		$340,000		$374,000
Marketing ($3 Per unit)		$ 60,000	$            400,000	$ 51,000	$425,000
Contribution margin			$            400,000		$402,500
Less: Fixed Cost
Manufacturing		$240,000		$240,000
Marketing		$ 80,000		$ 80,000
One Time Charges		$           -	$            320,000	$    2,500	$322,500
Operating Income			$              80,000		$ 80,000
Hence, any price above $29.50 per unit will increase Operating Income.
Part 3
GGI have both strategic and ethical issues.
From stratetic oint of view, GGI will face huge reputational loss if quality have any issues.
Since APAC has orders this to GGI mainly because of its reputation for quality.
Ethical issue is also there as APAC would be decieved if GGI give them third party product,
since APAC is expecting higher quality product from GGI.
To cater this, GGI should clearly tell APAC that they would need to fill a portion of
special order from third party. Alternatively, they can reduce the price also