In: Accounting
Huang Automotive is presently operating at 75% of capacity. The
company recently received an offer from a Korean truck manufacturer
to purchase 23,500 units of a power steering system component for
$195 per unit. Peter Wu, vice-president of sales, notes that
although there will be an additional $2.00 shipping cost for each
component, he thinks that accepting the order will get the
company's "foot in the door" of an expanding international
market.
Huang's production and cost information for the last two years for
the component are as follows:
195,000 units | 231,000 units | |
Direct material costs | $17,062,500 | $20,212,500 |
Direct labor costs | 5,655,000 | 6,699,000 |
Overhead costs | 23,712,500 | 25,782,500 |
Selling and administrative costs | 8,160,000 | 8,448,000 |
Total costs | $54,590,000 | $61,142,000 |
Total costs per unit | $279.95 | $264.68 |
T.J. Chan, vice-president of engineering, feels that any new market
should first show its profitability and that the $195 per unit
offer is not only below the regular $270 selling price, but it's
below the unit cost of the component. She also points out that
there will be additional setup costs of $240,000 and that Huang
will have to lease some special equipment for $270,000.
Required
1. Using the high-low method to determine cost behavior, what would
the expected profit be on the special order (use a negative sign
for a loss)?
Solution :
Per unit direct material cost = $1,70,62,500 / 195000 = $87.50 per unit
Per unit direct labor cost = $5,655,000 / 195000 = $29 per unit
Variable overhead cost per unit using high low method = (Cost at high level activity - Cost at low level activity) / (High level activity - Low level activity)
= ($25,782,500 - $23,712,500) / (231000 - 195000) = $57.50 per unit
Variable selling and administrative expense using high low method = ($8,448,000 - $8,160,000) / (231000 - 195000) = $8 per unit
Computation of expected profit from special order - Huang Automotive | |
Particulars | Amount |
Revenue from special order (23500 * $195) | $4,582,500.00 |
Relevant Costs: | |
Direct material (23500*$87.50) | $2,056,250.00 |
Direct labor (23500 * $29) | $681,500.00 |
Variable overhead (23500*$57.50) | $1,351,250.00 |
Variable selling and administrative expenses (23500*$8) | $188,000.00 |
Additional shipping cost (23500*$2) | $47,000.00 |
Additional setup costs | $240,000.00 |
Lease cost of special equipment | $270,000.00 |
Profit from special order | -$251,500.00 |