Question

Crystal winery produces premium wine. Its success in the industry is due to its quality, although all of its customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts on all large orders. Noting that the wine industry is becoming increasingly competitive, Crystal winery is looking for a way to meet the challenge. It is negotiating with Culinary Delights, a regional specialty grocery store, to purchase a large order of wine. Crystal winery is currently producing under-capacity and would like to keep its production facilities, gaining better economies of scale by increasing production. Culinary Delights has agreed to a large order but only at a price of $39 per bottle. The special order can be produced in one batch with available capacity. Crystal winery has prepared the following data related to next month's operations (per unit, for 10,000 bottles, made in 10 batches of 1,000 each)

Sales price	$	55
Per unit costs
Variable manufacturing costs		22
Variable marketing costs		10
Fixed manufacturing costs		6
Batch-related costs                                                           $5,000 per batch
Special order information (order is produced in one batch)
Sales units		2,000
Sales price per bottle	$	39

No variable marketing costs are associated with this order, but Crystal winery has spent $2,500 during the past two months trying to get Culinary Delights to place the special order. A special label needs to be designed for the special order, at a cost of $3,000 and printing costs for the new label would total $1,000.

Required:  How much will the special order change Crystal winery's total operating income?

Answer 1

Solution:

Contribution per unit from special order = Selling price per unit - variable manufacturing cost       

Particulars		Amount ($)
Selling Price per unit	Given	39
Less:
Variable Manufacturing Costs	Given	22
Batch related cost	$5000per batch / 2000units = $2.5	2.5
Contribution Per unit		14.5

Total operating Income of Crystal winery increases by = Contribution Per unit * no.of units sold

= $14.5 * 2000

= $29000

Note:

1) Given Batch Related cost = $5000

As the special order is produced in one Batch Batch related cost per unit = $5000/2000units = $2.5per unit

2) Fixed cost is irrelevant, as fixed cost will be incurred whether offer is accepted or not  

3) cost of $ 2500 incurred for getting special order is a sunk cost that is incurred in past.

4) As variable Marketing cost not associated with this special order it is not a revelant cost.

any issues concerning the above problem please comment .Thank you