Question

Case Study Gamma Company manufactures soft drinks. Its manufacturing plant has the capacity to produce 10,000 cases each month; current production and sales are 7,500 cases per month. The company normally charges $150 per case. Cost information for the current activity level is as follows:

Variable costs that vary with units produced

Direct materials ---------------------------------------------$ 262,500

Direct manufacturing labour -------------------------------- 300,000

Variable costs (for setups, materials handling, quality control, and so on) that vary with number of batches, 150 batches x $500 per batch ---------------------------------------75,000 Fixed manufacturing costs ------------------------------------275,000

Fixed marketing costs -----------------------------------------175,000

Total costs ---------------------------------------------------$ 1,087,500

Gamma Company has just received a special one-time-only order for 2,500 cases at $100 per case. Gamma Company usually makes its soft drinks for its existing customers in batch sizes of 50 case (150 batches x 50 cases per batch = 7,500 cases). The special order requires them to make the cases in 25 batches of 100 each. Required:

(a) Should Gamma Company accept this special order? Why? Explain briefly.

(b) Suppose plant capacity was only 9,000 cases instead of 10,000 cases each month. The special order must either be taken in full or rejected totally. Should Gamma Company accept the special order?

(c) As in requirement (a) assume that monthly capacity is 10,000 cases. Gamma Company is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of $10 in the month in which the special order is being filled. They would argue that Gamma Company capacity costs are now being spread over more units, and that existing customers should get the benefit of these lower costs. Should Gamma Company accept the special order under these conditions? Show all calculations

Answer 1

Since we are considering an additional order, we should be concerned only with the variable costs. The reason being that the fixed costs are already incurred each month and is fixed expense of Gamma, whether or not we accept any new order. Hence in our problem we will be wroking only with the variable costs. The solution is provided in a tabular format below for easy understanding:

Particulars	Currect calculation	Current	Case 1 calculation	Case 1	Case 2 calculation	Case 2	Case 3 calculation	Case 3
Direct material per case	262500/7500	35		35		35		35
Direct Labour per case	300000/7500	40		40		40		40
Variable cost	500*150 / 7500 case	10	500/batch *25 batch/2500 case	5		5		5
Total Variable Cost		85		80		80		80
Selling Price		150		100		100		100
Contribution per unit		65		20		20		20
Total additional Contribution			20per case *2500	50000	20per case *2500	50000	20per case *2500	50000
Contribution foregone from current sale				0	65 per unit*1000 case	65000	10 per case*7500 case	75000
Net Contribution				50000		-15000		-25000