Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 30,000 Rets per year. Costs associated with this level of production and sales are given below:

The Rets normally sell for $50 each. Fixed manufacturing overhead is constant at $270,000 per year within the range of 25,000 through 30,000 Rets per year.

Required:

1.         Assume that due to a recession, Polaski Company expects to sell only 25,000 Rets through regular channels next year. A large retail chain has offered to purchase 5,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 5,000 units. This machine would cost $10,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

2.         Refer to the original data. Assume again that Polaski Company expects to sell only 25,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 5,000 Rets. The Army would pay a fixed fee of $1.80 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

3.         Assume the same situation as that described in (2) above, except that the company expects to sell 30,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 5,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 5,000 Rets were sold through regular channels?

 

 

Answer 1

1.   Because the fixed costs will not change as a result of the order, they are not relevant to the decision. The cost of the new machine is relevant, and this cost will have to be recovered by the current order because there is no assurance of future business from the retail chain.

 

	Unit	Total x 5,000 units
Sales from the order ($50 × 84%)	$42	$210,000
Less costs associated with the order:
Direct materials	15	75,000
Direct labor	8	40,000
Variable manufacturing overhead	3	15,000
Variable selling expense ($4 × 25%)	1	5,000
Special machine ($10,000 ÷ 5,000 units)	2	10,000
Total costs	29	145,000
Net increase in profits	$13	$ 65,000

2.

Sales from the order:
Reimbursement for costs of production (variable production costs of $26 plus fixed manufacturing overhead cost of $9 = $35 per unit; $35 per unit × 5,000 units)	$175,000
Fixed fee ($1.80 per unit × 5,000 units)	9,000
Total revenue	184,000
Less incremental costs x variable production costs  ($26 per unit × 5,000 units)	130,000
Net increase in profits	$ 54,000

3.

Sales:
From the U.S. Army (above)	$184,000
From regular channels ($50 per unit × 5,000 units)	250,000
Net decrease in revenue	(66,000)
Less variable selling expenses avoided if the Army’s order is accepted ($4 per unit × 5,000 units)	20,000
Net decrease in profits if the Army’s order is accepted	$(46,000)

 

      Note: This answer assumes that regular customers will return after this one-time special order rather than buy from a competitor in the future.

Note: This answer assumes that regular customers will return after this one-time special order rather than buy from a competitor in the future.