Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 40,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	800,000
Direct labor		10				400,000
Variable manufacturing overhead		3				120,000
Fixed manufacturing overhead		5				200,000
Variable selling expense		4				160,000
Fixed selling expense		6				240,000
Total cost	$	48			$	1,920,000

The Rets normally sell for $53 each. Fixed manufacturing overhead is $200,000 per year within the range of 33,000 through 40,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 33,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 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 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 33,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 7,000 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. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 40,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 7,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1)	New contribution margin
	Selling price		53*(1-.16)			44.52
	less :Variable expense
	Direct materials				20
	Direct labor				10
	variable manufacturing overhead				3
	variable selling expense			(4*25%)	1
	total variable expense				34	-34
	New contribution margin					10.52
	total contribution margin			(7000*10.52)		73640
	less :cost of machine					-14,000
	Net income					59640
	financail advantage			59,640
2)	Fixed fee				2
	Fixed manufacturing overhead reimbursed				5
	total				7
	total contribution		7000*7		49000
	financial advantage		49,000
	(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					53
	less :Variable expense
	Direct materials				20
	Direct labor				10
	variable manufacturing overhead				3
	variable selling expense				4
	total variable expense				37	-37
	New contribution margin					16
	contribution lost		(7000*16)			-112000
	income from Army order					49,000
	Net loss					-63000
	Net profit will decrease by			-63000
	financial disadvantage			63,000	answer