Question

Sherene Nili manages a company that produces wedding gowns. She produces both a custom product that is made to order and a standard product that is sold in bridal salons. Her accountant prepared the following forecasted income statement for March, which is a busy month:

	Custom Dresses			Standard Dresses			Total
Number of dresses		10			20			30
Sales revenue	$	52,000		$	32,000		$	84,000
Materials	$	10,400		$	8,400		$	18,800
Labor		20,400			9,400			29,800
Machine depreciation		640			340			980
Rent		4,600			3,200			7,800
Heat and light		1,100			700			1,800
Other production costs								3,200
Marketing and administration								8,100
Total costs							$	70,480
Operating profit							$	13,520

Ms. Nili already has orders for the 10 custom dresses reflected in the March forecasted income statement. The depreciation charges are for machines used in the respective product lines. Machines depreciate at the rate of $1 per hour based on hours used, so these are variable costs. In March, cutting and sewing machines are expected to operate for 980 hours, of which 640 hours will be used to make custom dresses. The rent is for the building space, which has been leased for several years at $7,800 per month. The rent, heat, and light are allocated to the product lines based on the amount of floor space occupied.

A valued customer, who is a wedding consultant, has asked Ms. Nili for a special favor. This customer has a client who wants to get married in early April. Ms. Nili's company is working at capacity and would have to give up some other business to make this dress. She can't renege on custom orders already agreed to, but she can reduce the number of standard dresses produced in March to 10. Ms. Nili would lose permanently the opportunity to make up the lost production of standard dresses because she has no unused capacity for the foreseeable future. The customer is willing to pay $26,000 for the special order. Materials and labor for the order will cost $6,400 and $10,400, respectively. The special order would require 156 hours of machine time. Ms. Nili's company would save 170 hours of machine time from the standard dress business given up. Rent, heat and light, and other production costs would not be affected by the special order.

Required:

a-1.	Calculate the differential operating profit (loss).

a-2.	From an operating profit perspective for March, should Ms. Nili accept the order?
	Yes No

b.	What is the minimum price Ms. Nili should accept to take the special order?

Answer 1

1	CALCULATION OF DIFFERENTIAL OPERATING PROFIT
		Number of standard dresses planned	20
		Number of machine hours planned	340
		Machine hours per unit of standard dress	17	(340/20)
		Machine hours saved for giving up standard dress business	170
		Number of standard dresses reduced	10	(170/17)
		Sales revenue for 10 numbers standard dresses	$                        16,000	(10*(32000/20)
		Cost of materials for 10 standard dresses	$                           4,200	(10*(8400/20)
		Cost of labor for 10 standard dresses	$                           4,700	(10*(9400/20)
		Machine depreciation for 10 standard dresses	$                              170	(10*(340/20)
			Option of making	option of making
			Standard dress	Special order
		Sales revenue	$                        16,000	$26,000
		Variable Costs:
		Cost of materials	$                           4,200	$6,400
		Cost of labor	$                           4,700	$10,400
		Machine depreciation	$                              170	$156
		Total variable costs	$                           9,070	$                  16,956
		Contribution	$                           6,930	$                    9,044
	a.1	Differential Operating Profit=(9044-6930)=	$                           2,114
	a.2	From an operating profit perspective for March, should Ms. Nili accept the order?	YES
	b	Minimum price for special order=(26000-2114)	$23,886