Question

Davis Kitchen Supply produces stoves for commercial kitchens. The costs to manufacture and market the stoves at the company's normal volume of 6,000 units per month are shown in the following table.

Unit manufacturing costs
Variable materials	$	52
Variable labor		77
Variable overhead		27
Fixed overhead		62
Total unit manufacturing costs				$	218
Unit marketing costs
Variable		27
Fixed		72
Total unit marketing costs					99
Total unit costs				$	317

Required:

Unless otherwise stated, assume that no connection exists between the situation described in each question; each is independent. Unless otherwise stated, assume a regular selling price of $374 per unit. Ignore income taxes and other costs that are not mentioned in the table or in the question itself.

a.	Market research estimates that volume could be increased to 7,000 units, which is well within production capacity limitations if the price were cut from $374 to $329 per unit. Assuming that the cost behavior patterns implied by the data in the table are correct.

a-1.	What would be the impact on monthly sales, costs, and income?

Before Price Reduction After Price Reduction Impact Sales price Quantity Revenue Variable manufacturing costs Variable marketing costs Contribution margin Fixed manufacturing costs Fixed marketing costs Income

a-2.	Would you recommend taking this action?
	Yes No

b.

On March 1, the federal government offers Davis a contract to supply 1,000 units to military bases for a March 31 delivery. Because of an unusually large number of rush orders from its regular customers, Davis plans to produce 8,000 units during March, which will use all available capacity. If it accepts the government order, it would lose 1,000 units normally sold to regular customers to a competitor. The government contract would reimburse its "share of March manufacturing costs" plus pay a $48,000 fixed fee (profit). (No variable marketing costs would be incurred on the government's units.) Assuming that the government's "share of March manufacturing costs" will be the proportionate fixed manufacturing cost, what impact would accepting the government contract have on March income?

Without Government Contract With Government Contract Impact Regular Government Total Revenue Variable manufacturing costs Variable marketing costs Contribution margin Fixed manufacturing costs Fixed marketing costs Income

c.

Davis has an opportunity to enter a highly competitive foreign market. An attraction of the foreign market is that its demand is greatest when the domestic market's demand is quite low; thus, idle production facilities could be used without affecting domestic business. An order for 2,000 units is being sought at a below-normal price to enter this market. For this order, shipping costs will total $42 per unit; total (marketing) costs to obtain the contract will be $2,000. No other variable marketing costs would be required on this order, and it would not affect domestic business. What is the minimum unit price that Davis should consider for this order of 2,000 units?

d.	An inventory of 460 units of an obsolete model of the stove remains in the stockroom. These must be sold through regular channels (thus incurring variable marketing costs) at reduced prices or the inventory will soon be valueless. What is the minimum acceptable selling price for these units?

e-1

A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. Davis’s plant would operate at two-thirds of its normal level, and total fixed manufacturing costs would be cut by 25 percent. What in-house unit cost should be used to compare with the quotation received from the supplier? (Round your answer to 2 decimal places.)

e-2.	Should the proposal be accepted for a price (that is, payment to the outside contractor) of $217 per unit?
	Not accepted Accepted

f-1.

A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. The idle facilities would be used to produce 1,600 modified stoves per month for use in extreme climates. These modified stoves could be sold for $452 each, while the costs of production would be $277 per unit variable manufacturing expense. Variable marketing costs would be $52 per unit. Fixed marketing and manufacturing costs would be unchanged whether the original 6,000 regular stoves were manufactured or the mix of 4,000 regular stoves plus 1,600 modified stoves were produced. What in-house unit cost should be used to compare with the quotation received from the outside contractor? (Round your answer to 2 decimal places.)

f-2.	Should the proposal be accepted for a price of $217 per unit to the outside contractor?
	Accepted Not accepted

Answer 1

Answer a-1
	Before Price Reduction	After Price Reduction	Impact
Sales price	6,000.00	7,000.00
Quantity	374.00	329.00
Revenue	2,244,000.00	2,303,000.00	59,000.00	Increase
Variable manufacturing costs (52 + 77 + 27) per Unit	936,000.00	1,092,000.00	156,000.00	Increase
Variable marketing costs - $27 per Unit	162,000.00	189,000.00	27,000.00	Increase
Contribution margin	1,146,000.00	1,022,000.00	124,000.00	Decrease
Fixed manufacturing costs	372,000.00	372,000.00	-	None
Fixed marketing costs	432,000.00	432,000.00	-	None
Income	342,000.00	218,000.00	124,000.00	Decrease
Answer a-2.
No
Answer b.
	Without Government Contract	With Government Contract			Impact
		Regular	Government	Total
Sales price	8,000.00	7,000.00	1,000.00	8,000.00
Quantity	374.00	374.00	266.00
Revenue	2,992,000.00	2,618,000.00	266,000.00	2,884,000.00	108,000.00	Decrease
Variable manufacturing costs (52 + 77 + 27) per Unit	1,248,000.00	1,092,000.00	156,000.00	1,248,000.00	-	None
Variable marketing costs - $27 per Unit	216,000.00	189,000.00	-	189,000.00	27,000.00	Decrease
Contribution margin	1,528,000.00	1,337,000.00	110,000.00	1,447,000.00	81,000.00	Decrease
Fixed manufacturing costs	372,000.00	372,000.00	-	372,000.00	-	None
Fixed marketing costs	432,000.00	432,000.00	-	432,000.00	-	None
Income	724,000.00	533,000.00	110,000.00	643,000.00	81,000.00	Decrease
Variable Manufacturing Costs	156,000.00
Fixed Manufacturing Costs $372,000 X 1,000 / 6,000	62,000.00
Total Cost	218,000.00
Fixed Profit	48,000.00
Total revenue From Government Contract	266,000.00
Answer c.
Minimum Price Per Unit:
Variable Manufacturing Cost - $156 X 2,000 Units	112,000.00
Shipping Cost - $42 X 2,000 Units	84,000.00
Marketing Costs	2,000.00
Total costs of 2,000 Units	198,000.00
Minimum Price Per Unit	99.00
Answer d.
Minimum Acceptable Selling price - Obsolete Model = $27 per Unit
All other manufacturing costs are sunk costs, so we don't have to consider them.