Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 27,500 units of a power steering system component for $190 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.50 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market.

Huang's production and cost information for the last two years for the component are as follows:

	199,000 units	233,000 units
Direct material costs	$16,815,500	$19,688,500
Direct labor costs	5,870,500	6,873,500
Overhead costs	24,141,500	26,130,500
Selling and administrative costs	9,389,000	9,763,000
Total costs	$56,216,500	$62,455,500
Total costs per unit	$282.49	$268.05

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $190 per unit offer is not only below the regular $260 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $240,000 and that Huang will have to lease some special equipment for $230,000.

Required
1. Using the high-low method to determine cost behavior, what would the expected profit be on the special order (use a negative sign for a loss)?

Answer 1

	Year 1	Year 2	Changes
Number of units	199,000 units	233000 units	34000 units
	$
Direct material cost	16,815,500	19,688,500	2,873,000
Direct labor cost	5,870,500	6,873,500	1,003,000
Overhead cost	24,141,500	26,130,500	1,989,000
Selling and administrative cost	9,389,000	9,763,000	374,000
Total changes	56,216,500	62,455,500	6,239,000
Variable cost per unit = $ 6,239,000/ 34,000 units =			183.50
Total Variable costs in Year 1 ( 199,000 units x $ 183.5 )	36,516,500
Total fixed costs in Year 1 ( 56,216,500 - $ 36,516,500 )	19,700,000
Normal selling price	260.00
Less: Variable cost per unit	(183.50)
Normal contribution margin per unit	76.50
Selling price for the special order	190.00
Less: Variable cost per unit	(183.50)
Less: Additional shipping cost	(2.50)
Contribution margin per unit	4.00
Total contribution marging for the special order ( 27,500 units x $ 4 )	110,000
Less: Additional setup costs	(240,000)
Less: Cost of special equipment	(230,000)
Loss from special order.	(360,000)