Question

Burnt Company prints textbooks for sale to colleges. Currently, the company is operating at 80 percent of capacity. A large university has offered to buy 1,200 textbooks as long as the cover of the book can be customized with the university’s logo. While the normal selling price is $175 per textbook, the university has offered only $125 per textbook. Burnt Company can accommodate the special order without affecting current sales.

Unit cost information for a textbook is as follows:

Direct Materials $ 9.31

Direct Labor 9.65

Variable Overhead 6.43

Fixed Overhead 47.00

Total Unit Cost $72.39

Fixed overhead is $822,000 per year and will not be affected by the special order. Normally, there is a commission of 3.5 percent of price; this will not be paid on the special order. The special order will require additional fixed costs of $42,550 for the design and setup of the logo on each textbook.

Part A List the alternatives being considered.

Part B Which alternative is more cost effective and by how much?

Part C What if Burnt Company was operating at capacity and accepting the special order would require rejecting an equivalent number of textbooks sold to existing customers? Which alternative would be better? Explain.

Answer 1

Part A - Alternatives being considered

Alternative -1 Opertate at 80 % capacity and rejact the new order

Alternative -2 Accept the order and incur dditional cost of $ 42550 for design and setup of logo.

Part-B

Which Alternative is more cost effective.

For this an incremental analysis is required

Satetement of incremental Profit /(Loss) if order is accepted

S. no.	Particulars	Amount ($)
1	Additional Sales ( $125 per book X 1200 books)	150000
2	Less: Additional Expenses
a	Direct Matreial ( $9.31 X 1200 books)	(11172)
b	Direct Labour ( $9.65 X 1200 books)	(11580)
c	Variable Overheads ( $6.43 X 1200 books)	(7716)
d	Exisiting Fixed Overheads( No change)	-
e	Additional fixed overheads	(42550)
3	Add: Savings on commission( $175X3%X1200 books)	6300
	Net increase in profit if order accepted	83282

Alternative 2 is better by $ 83282.

Part C If firm has no additional capacity

Incremantal analysis will be as follows:

S no.	Particulars	Amount($)
1	Loss of contribution on 1200 books ( $50 X 1200 books)(see note below	(60000)
2	Saving in commission ( $175 X 3 % X1200 books)	6300
3	Additional fixed cost	(42550)
	Net Loss due to accepting order	(96250)

Note- Loss in contribution is the difference is because of difference in selling price.(i.e. $175-$125)

Conclusion : If there is no addtional capacity the order should not be accepted because it will result in decrease in net profit by $ 96250.