Question

Easton Company has a capacity to produce 50,000 comnputer monitors per year. The company is currently producing and selling 40,000 monitors per year at a selling price of $800 per monitor. The cost of producing and selling one monitor at the 40,000 unit level of activity is given in the table below:
Direct Material cost	$ 125
Direct Labor cost	$ 100
Variable manufacturing cost	$ 140
Fixed manufacturing cost	$ 150
Variable selling and administrative cost	$ 100
Fixed selling and administrative cost	$                  58
Total cost per unit	$ 673
The company has received a special order for 15,000 monitors at a unit price of $550. The company does not have to pay sales commission to the salesmen for the special order. Currently, the company pays a sales commission of $30 per monitor to its salesmen. The special order will have no effect on its fixed costs. The marketing manager has rejected the special order based on the following computation:
Special order price		$             550
Cost per monitor	$ 673
Less: sales commission avoided	$                  30
Cost per monitor for the special order		$             643
Net loss per monitor for the special order		$ (93)
Required:
a) You are reviewing the marketing manager's decision. What would you do? Would you accept or reject the order? Show computations to support your decision, especially the impact on company's profits from the special order
b) Regardless of what you answered in part (a), what is the minimum acceptable price for the special order?
c) Suppose the firm is selling 45,000 monitors currently. If the company wants to accept the special order, what is the minimum acceptable price? Assume that the cost structure given for an actitivy level of 30,000 monitors is applicable at this level of activity as well

Answer 1

(a) You are reviewing the marketing manager's decision. What would you do? Would you accept or reject the order? Show computations to support your decision, especially the impact on company's profits from the special order

	Reject	Accept	Net Income Increase (Decrease)
Revenue	$ 32,000,000	$ 36,250,000	$                  4,250,000
Variable cost:
Direct Material cost	$    5,000,000	$    6,250,000	$                (1,250,000)
Direct Labor cost	$    4,000,000	$    5,000,000	$                (1,000,000)
Variable manufacturing cost	$    5,600,000	$    7,000,000	$                (1,400,000)
Variable selling and administrative cost	$    4,000,000	$    4,550,000	$                    (550,000)
Total Variable cost	$ 18,600,000	$ 22,800,000	$                (4,200,000)
Contribution	$ 13,400,000	$ 13,450,000	$                        50,000

Accept the order. Income increase by $50000

(b)Regardless of what you answered in part (a), what is the minimum acceptable price for the special order?

Direct material cost (15000 * $125)	$ 1,875,000
Direct labor cost (15000 * $100)	$ 1,500,000
Variable manufacturing cost (15000 * $140)	$ 2,100,000
Variable selling & administration expense (15000 * $70)	$ 1,050,000
Opportunity cost	$ 1,675,000
Total cost	$ 8,200,000
÷ Units	15000
Minimum acceptable price	$        546.67

Explanations :-

Regular sale lost = 5000 units

Opportunity cost
Selling price	$              800
Less: Variable cost ($125 + $100 + $140 + $100)	$              465
Contribution per unit	$              335
X Units lost in reqular sale	5000
Opportunity cost	$ 1,675,000

(c)

Direct material cost (15000 * $125)	$ 1,875,000
Direct labor cost (15000 * $100)	$ 1,500,000
Variable manufacturing cost (15000 * $140)	$ 2,100,000
Variable selling & administration expense (15000 * $70)	$ 1,050,000
Opportunity cost	$ 3,350,000
Total cost	$ 9,875,000
÷ Units	15000
Minimum acceptable price	$        658.33

Explanations :-

Regular sale lost = 10000 units

Opportunity cost
Selling price	$              800
Less: Variable cost ($125 + $100 + $140 + $100)	$              465
Contribution per unit	$              335
X Units lost in reqular sale	10000
Opportunity cost	$ 3,350,000