Question

The Delmar Beverage Co. produces a premium root beer that is sold throughout its chain of restaurants in the Midwest. The company is currently producing 1,900 gallons of root beer per day, which represents 80% of its manufacturing capacity. The root beer is available to restaurant customers by the mug, in bottles, or packaged in six-packs to take home. The selling price of a gallon of root beer averages $13, and cost accounting records indicate the following manufacturing costs per gallon of root beer:

Raw materials	$	2.06
Direct labor		2.17
Variable overhead		2.11
Fixed overhead		1.53
Total absorption cost	$	7.87

In addition to the manufacturing costs just described, Delmar Beverage incurs an average cost of $1.05 per gallon to distribute the root beer to its restaurants.

  

SaveMore, Inc., a chain of grocery stores, is interested in selling the premium root beer in gallon jugs throughout its stores in the St. Louis area during holiday periods and has offered to purchase root beer from Delmar Beverage at a price of $10.00 per gallon. SaveMore believes it could sell 475 gallons per day. If Delmar Beverage agrees to sell root beer to SaveMore, it estimates the average distribution cost will be $1.52 per gallon.

a. Identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore?

b. How would Delmar Beverage’s daily operating income be affected by the acceptance of this offer? (Round your answer to 2 decimal places.)

      

Assume that Delmar Beverage is currently producing 2,375 gallons of root beer daily.

  

c-1. Identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore? (Round your answers to 2 decimal places.)

       

c-2. How would Delmar Beverage’s daily operating income be affected by the acceptance of this offer? (Round your answer to 2 decimal places.)

Answer 1

Solution a:

Existing capacity of Delmar = 1900/80% = 2375 gallon per day

Capacity utilization = 1900 gallon per day

Spare capacity = 2375 - 1900 = 475 gallon per day

Therefore, Delmar is having sufficient capacity to fulfill the special order without affecting the regular sale.

Computation of Relevant cost per gallon for special order - Delmar Beverage Co
Particulars	Amount
Raw material	$2.06
Direct labor	$2.17
Variable overhead	$2.11
Distribution cost	$1.52
Total relevant cost per gallon	$7.86

Solution b:

Daily income from special order = ($10 - $7.86) * 475 = $1,016.50

Therefore Delmar Beverage’s daily operating income will increase by $1,016.50 on acceptance of special order.

Solution c1:

As delmar is currently producing 2375 gallon for root beer daily, therefore there is no spare capacity available for special order. If special order is accepted, it will result in loss of regular sales.

Regular contribution margin per unit = $13 - $2.06 - $2.17 - $2.11 - $1.05 = $5.61 per unit

Computation of Relevant cost per gallon for special order - Delmar Beverage Co
Particulars	Amount
Raw material	$2.06
Direct labor	$2.17
Variable overhead	$2.11
Distribution cost	$1.52
Loss of regular contribution margin per unit	$5.61
Total relevant cost per gallon	$13.47

Solution c-2:

Daily income/(Loss) from special order = ($10 - $13.47) * 475 = ($1,648.25)

Therefore Delmar Beverage’s daily operating income will decrease by $1,648.25 on acceptance of special order.