Question

Ironwood Company manufactures a variety of sunglasses. Production information for its most popular line, the Clear Vista (CV), follows:

	Per Unit
Sales price	$	48.50
Direct materials		17.00
Direct labor		10.00
Variable manufacturing overhead		3.00
Fixed manufacturing overhead		5.00
Total manufacturing cost	$	35.00

Suppose that Ironwood has been approached about producing a special order for 2,500 units of custom CV sunglasses for a new semiprofessional volleyball league. All units in the special order would be produced in the league’s signature colors with a specially designed logo emblem attached to the side of the glasses. The league has offered to pay $44.00 per unit in the special order. Additional costs for the special order total $2.00 per unit for mixing the special frame color and purchasing the emblem with the league’s logo that will be attached to the glasses.

Required:
1. Assume Ironwood has the idle capacity necessary to accommodate the special order. Calculate the additional contribution margin Ironwood would make by accepting the special order.

2-a. Calculate the current contribution margin per unit.

2-b. Suppose Ironwood is currently operating its production facility at full capacity and accepting the special order would mean reducing production of its regular CV model. Should Ironwood accept the special order in this case?

3. Calculate the special order price per unit at which Ironwood is indifferent between accepting or rejecting the special order.

The Rosa model of Mohave Corp. is currently manufactured as a very plain umbrella with no decoration. The company is considering changing this product to a much more decorative model by adding a silk-screened design and embellishments. A summary of the expected costs and revenues for Mohave’s two options follows:

	Rosa Umbrella			Decorated Umbrella
Estimated demand		28,000	units		28,000	units
Estimated sales price	$	30.00		$	40.00
Estimated manufacturing cost per unit
Direct materials	$	20.50		$	22.50
Direct labor		4.50			7.00
Variable manufacturing overhead		3.50			5.50
Fixed manufacturing overhead		6.00			6.00
Unit manufacturing cost	$	34.50		$	41.00
Additional development cost				$	12,000

Required:
1. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
2. Should Mohave add decorations to the Rosa umbrella?
3-a. Suppose that the higher price of the decorated umbrella is expected to reduce estimated demand for this product to 26,000 units. Determine the increase or decrease in profit if Mohave sells the Rosa Umbrella with the additional decorations.
3-b. Should Mohave add decorations to the Rosa umbrella?

Answer 1

1.

SPECIAL ORDER
PARTICULARS	AMOUNT
SALES PRICE	44
DIRECT MATERIAL	17
DIRECT LABOUR	10
VARIABLE MANUFACTURING OVERHEAD	3
ADDITIONAL COST OF LOGO	2
TOTAL VARIABLE COST	32
CONTRUBUTION(SALE PRICE-V.COST)	12
UNITS	2500
ADDITIONAL CONTRIBUTION MARGIN	30000

2a.

PARTICULARS	AMOUNT
SALES PRICE	48.5
DIRECT MATERIAL	17
DIRECT LABOUR	10
VARIABLE MANUFACTURING OVERHEAD	3
TOTAL VARIABLE COST	30
CONTRUBUTION(SALE PRICE-V.COST)	18.5

2B. IRONWOOD SHOULDN'T ACCEPT THIS ORDER AS NEW CONTRIBUTION IS $12 UNIT INSPITE OF $18.5 UNIT OF OLD CV MODEL.

3. TOTAL VARIABLE COST OF NEW MODEL=$32

CONTRIBUTION OF OLD CV MODEL =$18.5

PRICE TO BE CHARGED FROM NEW ORDER=$50.5

$50.5 PRICE FOR NEW ORDER MAKE IT INDIFFERENT FOR IRONWOOD AS THERE IS SAME CONTRIBUTION.

ROSA MODEL

PARTICULARS	ROSA MODEL	NEW MODEL
SALES PRICE	30	40
DIRECT MATERIAL	20.5	22.5
DIRECT LABOUR	4.5	7
VARIABLE MANUFACTURING OVERHEAD	3.5	5.5
TOTAL VARIABLE COST	28.5	35
CONTRUBUTION(SALE PRICE-V.COST)	1.5	5

	ROSA MODEL	NEW MODEL
QUANTITY	28000	28000
CONTRIBUTION	1.5	5
FIXED COST	6	6
LOSS PER UNIT	-4.5	-1
TOTAL LOSS	-126000	-28000
COST OF NEW EQUIPMENT		12000
TOTAL LOSS	-126000	-40000

NEW MODEL RESULTED INTO REDUCING LOSS OF$86000(126000-40000)

2. YES HE SHOULD ADD DECORATION AS IT RESULTS INTO REDUCING LOSS.

3.

	ROSA MODEL	NEW MODEL
QUANTITY	28000	26000
CONTRIBUTION	1.5	5
TOTAL CONTRIBUTION	42000	130000
FIXED OVERHEAD(28000*6)	168000	168000
ADDITIONAL DEVELOPMENT COST		12000
PROFIT/LOSS	-126000	-50000

B. YES HE SHOULD ADD AS IT RESULTED INTO REDUCING LOSS OF $76000.