Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 34,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	680,000
Direct labor		8				272,000
Variable manufacturing overhead		3				102,000
Fixed manufacturing overhead		7				238,000
Variable selling expense		4				136,000
Fixed selling expense		6				204,000
Total cost	$	48			$	1,632,000

The Rets normally sell for $53 each. Fixed manufacturing overhead is $238,000 per year within the range of 25,000 through 34,000 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 9,000 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 9,000 units. This machine would cost $18,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

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 9,000 Rets. The Army would pay a fixed fee of $1.60 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. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 34,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 9,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1. Financial advantage : $ 94,680.

Price for the special order = $ 53 x 0.84 = $ 44.52

Variable cost per unit for the special order :

	$
Direct Materials	20.00
Direct Labor	8.00
Variable Manufacturing Overhead	3.00
Variable Selling Expenses	1.00
Total Variable Cost per Unit	$ 32.00

Contribution Margin per Unit = $ 44.52 - $ 32 = $ 12.52

Financial advantage (disadvantage) of accepting the special order = Contribution Margin on the Special Order - Cost of Special Equipment = $ 12.52 x 9,000 units - $ 18,000 = $ 94,680.

Fixed manufacturing and selling expenses are not relevant, as they do not change regardless of the output in the given range of 25,000 to 34,000.

2. Financial advantage : $ 77,400

Sales Revenue from the special order = 9,000 x $ ( 31 + 7 + 1.60) = $ 356,400

Variable costs for the special order = 9,000 x $ 31 = $ 279,000.

Financial advantage = $ ( 356,400 - 279,000) = $ 77,400

Again, fixed costs are not relevant as they will remain at the same level, regardless of the volume of output.

3. Financial disadvantage : $ ( 84,600)

Contribution margin per unit from regular sales = $ 53 - $ ( 20 + 8 + 3 + 4) = $ 18

Contribution margin lost on giving up regular orders in order to accommodate special order = 9,000 x $ 18 = $ 162,000.

Financial advantage ( disadvantage) of accepting the U,S. Army special order = $ 77,400 - $ 162,000 = $ ( 84,600)