Question

The Purple Haze Co has the capacity to produce 9,000 umbrellas per year. The company, using statistical analysis, projects the following:

Sales = 6,000 @ $10 for a total of $60,000
Manufacturing Costs
Variable	$4 per unit
Fixed	$15,000
Selling & Administrative
Variable	$1 per unit
Fixed	$4,000

Use the data above to answer the following: Should the company accept a special order (as explained in the chapter, this means you will continue to do the business you are now doing - $60,000 plus the new sales ) for 1,000 units at a price of $6 if:

1. There will be no variable selling & administrative costs for the special order. Should they take the special order based purely on the financial information? (They will continue to sell the 6,000 units they sell now as well as the new units and the fixed costs of $19,000 will remain at $19,000)
2. Assume the same facts as in Question 1 except that there will be a $2,000 set up fee for the special order and the fixed costs other $19,000 will remain at $19,000. Should they take the special order based purely on the financial information?
3. How would your analysis change if the company only had the capacity to produce 6,000 units?
4. What other factors need to be considered?
5. Identify the stakeholders and evaluate the potential impact on each stakeholder.

Note: Must answer part 5

Answer 1

First of all let's calculate the profit we are getting on normal order:

Sales. (6000*$10) $60000

Less: Variable Costs

Manufacturing(6000*4) $24000

Selling & Admin(6000*1) $6000

CONTRIBUTION. $30000

Less: Fixed Cost

Manufacturing. $15000

Selling and Admin. $4000

PROFITS. $11000

1. Special Order of 1000 units @ $6 per unit

Sales.(1000*$6) $6000

Less: Variable Cost

Manufacturing(1000*4) $4000

PROFITS. $2000

#We have not taken fixed cost because it won't change due to change in numver of units produced below its capacity.

Total Profits = $11000 + $2000 = $13000

Conclusion: Since, special order is itself able to cover its cost and also generating an additional profit of $2000. Therefore, this should be accepted.

2. Special order(same as part 1) but with an additional set up cost of $2000

If the cost is increased by $2000 then it will reduces the profits by $2000

PROFITS(As above in part 1) $2000

Less: Additional set up cost. ($2000)

PROFIT in situation 2. $0

It means neither we are making any profit and nor we are incurring any loss.

When it comes to overall profits -

= $11000(Normal sales) + $0(Special order)

= $11000

In this situation, it depends upon company that how it will deal with this scenerio. But according to me, it should reject that propsal because company is running to do business and making profits and they are not doing any social work here. Therefore, producing extra units over its budgeted sales for nothing is useless.

But, it can also accept this order to saves business relation and enhance their goodwill.

3. Special order (same as part 1) but the maximum producing capacity is changed from 9000 units to 6000 units.

In this kind of situation, since the total sales includind special order exceeds the maximum capacity of the company. Therefore, we need to check the profitability of special order by sacrificing some units from reguler sales.

Expected sales - 6000units

Maximum capacity -6000 units

Since, we donot have excess capacity then the whole special order is need to be deducted from expected sales.

Expected sales(After special order)

= 6000 units - 1000 units

= 5000 units

Calculation of lost contribution margin

= $10(selling price) - $4(Mfg. Variable cost ) - $1(Selling & admin variable cost)

= $5

Value of lost contribution

= Units taken from expected sales * lost contribution margin

= 1000 units * $5

= $5000

Lost contribution margin per unit

= Value of lost Contribution/No. of unit of special order

= $5000/1000 units

= $5

#Don't get confused between No. of units of special order and No. of units taken from expected sale both are different. In, this question since there is no excess capacity(Max. Capacity> Exoected sales) therefore we had taked entire no. of units of special order from expected sales. Example: Like suppose, if max capacity is 6500 units then we will take 500 units from excess capacity and the rest from exoected sales.

Now, the total cost to fulfill the soecial order is

= $4(Variable Mfg. Cost) + $5(Lost of contribution per unit)

= $9

We can clearly see that the total cost per unit is exceed the total revenue per unit($9 > $6)

That's why, company should not accept this order unless it will incurr a loss of $3 oer unit.

4. Factors need to be considered before accepting a proposal.

a. The amount of Fixed cost

b. The capacity required to fulfill special order

c. Price offer > Cost of producing

d. Qualitative Factors

e. Check whether it is complying with fair pricing legislations.