Question

BLS, AG Skis (BLS), a Swiss company, produces cross-country ski poles that it sells for 18 euros (€) a pair. Operating at capacity, the company can produce 100,000 pairs of ski poles a year, for which it would have costs as indicated below: Production Costs: Per unit at 100,000 unit capacity level Total Unit costs 8 € 800,000 € Product level costs 1 100,000 Facility costs 3 300,000 Selling Costs: Variable 1 100,000 Fixed 2 200,000 Total costs 15 € 1,500,000 € The Swiss army offers to make a one-time-only purchase of 10,000 pairs of ski poles for its mountain troops. The army would pay a fixed fee of 3 € per pair and would reimburse BLS for 100 percent of its average variable and fixed manufacturing costs per unit (based on capacity). Due to a recession, the company would otherwise produce and sell only 80,000 pairs of ski poles this year. However, the company would not incur its usual variable selling expenses with this special order. No other product or facility costs will change. Hint: Assume that Unit costs are variable with respect to units; Product level and Facility costs are fixed with respect to units. Required: 1. What is BLS’s contribution margin ratio (round to nearest 1 percent) on normal sales of the ski poles (assume that product level costs and above are fixed)? 2. Assume that BLS has excess capacity: a. What is the minimum price per unit below which BLS should reject the order? b. If BLS accepts the army’s offer, by how much will net operating income increase (decrease) from the 80,000 pair level? 3. Assume that BLS has NO excess capacity (i.e., its operating at full capacity, selling 100,000 pairs of ski poles through regular channels). Thus, the sale to the army would require giving up sales of 10,000 pairs at the normal price of 18 € per pair. a. What is the minimum price per unit below which BLS should reject the order? b. If the army’s offer is accepted, by how much will net operating income increase (or decrease) from what it would be if the 10,000 pairs were instead sold through the regular channels? 4. State 2 qualitative factors that BLS should consider in this decision?

Answer 1

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1. Contribution Margin on Normal Sale
Sale Price		€                18
Less: Variable Unit Cost		€                  8
Contribution Margin		€                10
2a. Minimum Price
Variable Cost should be atleast covered		€                  8
2b. Increase/(Decrease) in income
Revenue from Army's offer	(15+3)*10000	€      180,000
Less: Variable Cost	10000*8	£        80,000
Increase in Profit		£      100,000
3a. Minimum Price
Variable Cost		€                  8
Add: Contribution margin per unit lost		€                10
Minimum Price		€                18
3b. Increase/(Decrease) in income
Revenue from Army's offer	(15+3)*10000	€      180,000
Less: Contribution Lost	10000*10	€      100,000
Less: Variable Cost	10000*8	£        80,000
Increase in Profit		£                 -
4. Qualitative Factor
1. It should not impact pricing to other customers.
2. Long Term Future effect on profitabilty