Question

Alton Inc. is working at full production capacity producing 23,000 units of a unique product. Manufacturing costs per unit for the product are as follows:

Direct materials	$	8
Direct labor		7
Manufacturing overhead		9
Total manufacturing cost per unit	$	24

The per-unit manufacturing overhead cost is based on a $5 variable cost per unit and $92,000 fixed costs. The nonmanufacturing costs, all variable, are $10 per unit, and the sales price is $44 per unit.

Sports Headquarters Company (SHC) has asked Alton to produce 5,600 units of a modification of the new product. This modification would require the same manufacturing processes. However, because of the nature of the proposed sale, the estimated nonmanufacturing costs per unit are only $5 (not $10). Alton would sell the modified product to SHC for $34 per unit.

Required

1-a. Calculate the contribution margin for 5,600 units for both the current and special order.

1-b. Should Alton produce the special order for SHC?

2. Suppose that Alton Inc. had been working at less than full capacity to produce 18,700 units of the product when SHC made the offer. What is the minimum price per unit that Alton should accept for the modified product under these conditions?

Answer 1

1-a.

Total Contribution Margin for 5600 units = $78400

Total Contribution Margin for 5600 units = $50400

Solution:

CM ratio = CM per unit/selling price per unit

Where,

CM per unit = selling price per unit – variable cost per unit

For current order

CM per unit = $44 - $30

= $14

Total CM for 5600 units = $14*5600 = $78400

For Special order

CM per unit = $34 - $25

= $9

Total CM for 5600 units = $9*5600 = $50400

Note 1:
Variable cost per unit (Current order):

	Amount
Direct materials	8
Direct labor	7
Variable Manufacturing overhead	5
Variable Nonmanufacturing overhead	10
Total variable costs	30

Variable cost per unit (Special order):

	Amount
Direct materials	8
Direct labor	7
Variable Manufacturing overhead	5
Variable Nonmanufacturing overhead	5
Total variable costs	25

1-b.

Alton Inc. should not produce special order for SHC

Because, Alton Inc. is operating at full capacity. If it accepts the special order then the operating profit reduces by $28000 [($14-$9)*5600 units or ($78400 - $504000)]

2. Minimum price per unit that Alton should accept for the modified product under these conditions = $25 per unit

Solution:

When the entity is not operating at full capacity then entity can accept the special order as it has the excess capacity to produce the units of special order. The minimum price depends on the variable cost per unit of that special order, in this case variable cost per unit of the special order is $25 per unit. So this is going to be the minimum price for special order.

This is because anything below $25 per unit results in reduction in profits earned by the current order units.