Question

This is a special order problem that also requires that you use the high low method to estimate some cost function parameters, so you may want to review the high-low method lectures in Module 1. As with almost all of the analyses that we have done, determining variable and fixed costs, and knowing what to do with them, is critical.
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Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 27,000 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 $2.00 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:

	201,000 units	225,000 units
Direct material costs	$17,286,000	$19,350,000
Direct labor costs	4,623,000	5,175,000
Overhead costs	24,256,000	25,600,000
Selling and administrative costs	10,308,500	10,512,500
Total costs	$56,473,500	$60,637,500
Total costs per unit	$280.96	$269.50

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 $270 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $210,000 and that Huang will have to lease some special equipment for $200,000.

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.________

Answer 1

Answer: -$18500

There would be an expected loss of $18,500 on the special order.

Working:

Selling price per unit $		190
Variable costs:
Direct materials	86
Direct labor	23
Variable overhead costs	56
Variable selling and administrative costs	8.5
Variable additional shipping costs	2
Total variable costs		175.5
Contribution per unit $		14.50
Number of units ordered		27000
Total contribution $		391500
Less: Additional setup costs		210000
Less: Cost of leasing special equipment		200000
Expected profit (loss) on special order $		-18500

Note: Fixed manufacturing overheads and fixed selling and administrative overheads are not considered since they are irrelevant as they remain unaffected by the acceptance or rejection of the special order since Huang has unutilized capacity.

	201000 units	225000 units	Variable cost per unit	Total Fixed cost
Direct material costs	17286000	19350000	86	0
Direct labor costs	4623000	5175000	23	0
Overhead costs	24256000	25600000	56	13000000
Selling and administrative costs	10308500	10512500	8.5	8600000
Total $	56473500	60637500	173.5	21600000

	Units	Direct material	Direct labor	Overhead	Selling and administrative
High activity level	225000	19350000	5175000	25600000	10512500
Low activity level	201000	17286000	4623000	24256000	10308500
Change	24000	2064000	552000	1344000	204000
Variable cost per unit $		86	23	56	8.5
		($2064000/24000)	($552000/24000)	($1344000/24000)	($204000/24000)
Fixed cost (at high level)		0	0	13000000	8600000
Fixed cost (at low level)		0	0	13000000	8600000