Question

Think Big Ltd has received a special order for 2,000 units of its product X at a special price of $60. The product normally sells for $80 and has the following manufacturing costs:

	Per unit
Direct materials	$24
Direct labour	16
Variable manufacturing overhead	12
Fixed manufacturing overhead	20
Unit cost	$72

The company has sufficient capacity to fill the order without harming normal production and sales and all fixed overhead is unavoidable.

The production department is currently facing a constraint of resources on producing three products with a shortage of machine hours since one of its two machines is down – only 360 hours are available this month. The selling price, costs, labour requirements, and demand of the three products are as follows:

	Product A	Product B	Product C
Selling price	$5.00	$3.00	$5.00
Variable cost per unit	$3.50	$2.00	$2.00
Machine hours per unit	0.75	0.25	1
Demand (units)	300	400	210

Required:

1. For making a decision on acceptance of the special order:

1. Calculate the effect on the company’s short-term profit on accepting the order.
2. Determine the minimum price to charge in order to achieve an incremental profit of $20,000.
3. Assuming the company is currently operating at full capacity, what effect will the order have on the company's short-term profit?

2. For making a decision on prioritization of products when the machine is down:

1. Determine the units of each products to be produced and sold to maximise profit.
2. Calculate the total contribution margin earned based on your production plan determined in (i) above.

Answer 1

a.
i.

Special Order
Sales Revenue	$       120,000
Variable Costs
Direct Material	$         48,000
Direct Labor	$         32,000
Variable Manufacturing Overhead	$         24,000
Total Costs	$       104,000
Profit (Loss)	$         16,000

ii Price to be charged for incremental profit of $20000 = ($20000+104000)/2000 = $62 per unit

iii Since, there is no idle capacity, there will be loss on accepting order.
Loss = 2000 x ($80-60) = $40000

b.
i

	Product A	Product B	Product C
Selling Price	$              5.00	$              3.00	$              5.00
Variable Cost per unit	$              3.50	$              2.00	$              2.00
Contribution Margin per unit	$              1.50	$              1.00	$              3.00
Machine hours per unit	0.75	0.25	1
Contribution Margin per machine hour	$              2.00	$              4.00	$              3.00
Demand	300	400	210
Machine hours required	225	100	210
Machine hours used	50	100	210
Units to be produced	66	400	210

Machine hours is used on ranking on basis of highest contribution margin per machine hour

ii)

Units to be produced	66	400	210
Contribution Margin	$           99.00	$         400.00	$         630.00

Contribution Margin earned = $1129