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	$	15			$	510,000
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	$	43			$	1,462,000

The Rets normally sell for $48 each. Fixed manufacturing overhead is $238,000 per year within the range of 28,000 through 34,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 28,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 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 6,000 units. This machine would cost $12,000. 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 28,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.40 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 6,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

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Polaski
Particulars	Details	Amount	Price per unit
No. of units produced	34,000.00	34,000.00
Sell price per unit			48.00	A
Direct Material		510,000.00	15.00
Direct Labor		272,000.00	8.00
Variable Manufacturing overhead		102,000.00	3.00
Variable selling expense		136,000.00	4.00	C
Total Variable cost per unit			30.00
Contribution per unit			18.00	G
Fixed Manufacturing overhead		238,000.00	7.00
Fixed selling expense		204,000.00	6.00
Total Fixed cost per unit			13.00
Current Scenario
Units Sold	28,000.00
Contribution earned		504,000.00
Less:
Fixed Manufacturing overhead		238,000.00
Fixed selling expense		204,000.00
Net Profit		62,000.00
Situation 1- Offer of Retail Chain
Reduction in Sell price by	16%
Reduction in Sell price per unit	7.68			B=A*16%
Reduction in Variable selling expense	75%
Reduction in Variable selling expense	3.00			D=C*75%
Revised Sell price per unit		40.32		E=A-B
Less:
Direct Material		15.00
Direct Labor		8.00
Variable Manufacturing overhead		3.00
Variable selling expense		1.00		F=C-D
Total Variable cost per unit		27.00
Contribution per unit		13.32
No. of Units		6,000.00
Total Contribution		79,920.00
Less: Cost of special machine		12,000.00
Net income		67,920.00

Conclusion: By selling the remaining 6,000 units Polaski Company can earn an additional profit $ 67,920. So they should accept this project.

Note: Fixed manufacturing and selling expenses are sunk cost and they should not be considered for this order.

Situation 2- US Army
Fixed Fee per unit	1.40
Fixed manufacturing overhead per unit	7.00
Net received per unit	8.40
No. of Units	6,000.00
Total received	50,400.00

Conclusion: By selling the remaining 6,000 units to US army Polaski Company can earn an additional profit $ 50,400. So they should accept this project.

Situation 3- US Army
Particulars		Sales through regular channel	Provincial Government
Units Sold		34,000.00	28,000.00	H
Contribution earned		612,000.00	504,000.00	I=H*G
Less:
Fixed Manufacturing overhead		238,000.00	238,000.00
Fixed selling expense		204,000.00	204,000.00
Net Income		170,000.00	62,000.00
Add: Total received from US Army			50,400.00	Calculated in Situation 2 above
Net Profit		170,000.00	112,400.00
Variance			57,600.00

Conclusion: If Polaski company is able to sell all its units through regular channel then it should not sell to US Army. Because it will earn $ 57,600 less if it will sell to US Army.