Question

Alton Inc. is working at full production capacity producing 40,000 units of a unique product. Manufacturing costs per unit for the product are as follows: Direct materials $ 11 Direct labor 10 Manufacturing overhead 12 Total manufacturing cost per unit $ 33 The per-unit manufacturing overhead cost is based on a $6 variable cost per unit and $240,000 fixed costs. The nonmanufacturing costs, all variable, are $8 per unit, and the sales price is $68 per unit. Sports Headquarters Company (SHC) has asked Alton to produce 6,600 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 $4 (not $8). Alton would sell the modified product to SHC for $53 per unit. Required 1-a. Calculate the contribution margin for 6,600 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 34,000 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

1a)

	Current order	Special order
Sales (i)	6,600 x 68 = 448,800	6,600 x 53 = 349,800
Variable expenses:
Direct material	6,600 x 11 = 72,600	6,600 x 11 = 72,600
Direct labor	6,600 x 10 = 66,000	6,600 x 10 = 66,000
Manufacturing overhead	6,600 x 6 = 39,600	6,600 x 6 = 39,600
Non-manufacturing overhead	6,600 x 8 = 52,800	6,600 x 4 = 26,400
Total variable expenses (ii)	231,000	204,600
Contribution margin (i) - (ii)	$217,800	$145,200

1b)

Special order should not be accepted since the total contribution margin of the special order is less than contribution margin of the current order.

2.

If Alton Inc. had been working at less than full capacity to produce 34,000 units of the product when SHC made the offer, then there is excess capacity to produce 6,000 more units. Special order size is 6,600 units. Hence, current production should be reduced by 600 units in order to fulfil the special order. Hence, special order should cover the variable expenses and loss of contribution from 600 units of the current production.

Contribution margin per unit of the current order = Selling price per unit - Variable expenses per unit

= 68 - 35

= $33

Total variable expenses of the special order	204,600
Contribution margin lost due to acceptance of special order (600 x 33)	19,800
Total cost of the special order	$224,400

Minimum price per unit of the special order = Total cost of the special order/Number of units in the special order

= 224,400/6,600

= $34