Question

The Delmar Beverage Co. produces a premium root beer that is sold throughout its chain of restaurants in the Midwest. The company is currently producing 2,048 gallons of root beer per day, which represents 90% of its manufacturing capacity. The root beer is available to restaurant customers by the mug, in bottles, or packaged in six-packs to take home. The selling price of a gallon of root beer averages $14, and cost accounting records indicate the following manufacturing costs per gallon of root beer: Raw materials $ 2.56 Direct labor 2.17 Variable overhead 1.61 Fixed overhead 1.53 Total absorption cost $ 7.87 In addition to the manufacturing costs just described, Delmar Beverage incurs an average cost of $1.05 per gallon to distribute the root beer to its restaurants. SaveMore, Inc., a chain of grocery stores, is interested in selling the premium root beer in gallon jugs throughout its stores in the St. Louis area during holiday periods and has offered to purchase root beer from Delmar Beverage at a price of $11.00 per gallon. SaveMore believes it could sell 227 gallons per day. If Delmar Beverage agrees to sell root beer to SaveMore, it estimates the average distribution cost will be $1.52 per gallon. Required: Identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore, how would Delmar Beverage’s daily operating income be affected by the acceptance of this offer, identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore, and how would Delmar Beverage’s daily operating income be affected by the acceptance of this offer?

Answer 1

a)Total relevant costs per gallon for Special Sales Order

Raw Materials	$       2.56
Direct Labor	$       2.17
Variable Overhead	$       1.61
Distribution	$       1.52
Total relevant costs per gallon	$       7.86

b) Delmar Beverage’s daily operating income be affected by the acceptance of this offer.. It will increase by 712.78

Sales price	$    11.00
Relevant Cost	$       7.86
Contribution margin per gallon	$       3.14
Daily sales in gallons	227.00
Daily increase in operating income	$ 712.78

c)  

Current Sales		$    14.00
Less: Variable cost
Raw Materials	$       2.56
Direct Labor	$       2.17
Variable Overhead	$       1.61
Distribution	$       1.05
		$       7.39
Current Contribution Margin		$       6.61

So operating income will decrease by 227*(6.61-3.14)= $787.69