Question

7. Old Vine Vineyard produces premium wine. Its success in the industry is due to its quality, although all 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, Old Vine is looking for a way to meet the challenge. It is negotiating with Eastern Seasons, a regional specialty grocery store, to purchase a large order of wine. Old Vine is currently producing at under-capacity and would like to keep its production facilities, gaining better economies of scale by increasing production. Western Seasons has agreed to a large order but only at a price of $31 per bottle. The special order can be purchased in one batch with available capacity. Old Vine prepared these data:Next month's operating information (per unit, for 10,000 bottles, made in 10 batches of 1,000 each):Sales Price$46Per Unit costs: Variable manufacturing costs16Batch level costs 4Variable marketing costs 9Fixed manufacturing costs 6Fixed marketing costs 1Special order information – order is produced in one batchSales units2,000Sales price per bottle $31No variable marketing costs are associated with this order, but Old Vine has spent $2,500 during the past two months trying to get Western Seasons to purchase the special order

Required: A. How much will the special-order change Old Vine's total operating income?B. How much would the special-order change Old Vine's total operating income if Old Vine is operating at full capacity and would lose the sale of the 2,000 bottles to regular customers?C. How might the special-order fit into Old Vine's competitive strategy?

Answer 1

particular	"$"
Sales		46
Variable Costs:
Variiable Manufacturing Cost	16
Variable marketing cost	9
Batch level cost	4
Total Variable cost		29
Contribution per unit		17
Fixed Costs:
Fixed Manufacturing Cost	6
Fixed Marketing cost	1
Total Fixed cost		7
Net Operating Income per unit		10
Total operating income for 10,000 units		100000

A. Change in operating Income due to special order: - (We have spare capacity)

Contribution from special order = 2,000 units x $(31 - 16 - 4) - $2,500

   = $19,500

Therefore the operating income of Old Vine increased by $19,500

B. Change in operating Income due to special order: - (No spare capacity)

Here we dont have any spare capacity. Old vine is operating at full capacity. Therefore in this situation total cost will be Variable cost plus contribution lost.

Total cost = Variable Cost + contibution lost

   = $(16 + 4) + 29 = $49 per unit

Net operating loss = 2,000 x $(49 - 31) + $2,500 = $38,500

Therefore the operating income of Old Vine dereased by $38,500.

C. From the above points we can see that the company's best strategy with respect to special order must be when the company is having spare capacity which leads to an overall profit increase of $19,500. When the company is already working at full capacity then accepting the special order leads to a huge loss of $38,500.

Thannk you