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	$	55
Variable labor		80
Variable overhead		30
Fixed overhead		65
Total unit manufacturing costs				$	230
Unit marketing costs
Variable		30
Fixed		75
Total unit marketing costs					105
Total unit costs				$	335

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 $380 per unit. Ignore income taxes and other costs that are not mentioned in the table or in the question itself.

Required:

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 $380 to $335 per unit. Assume 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? (Select option "increases" or "decrease", keeping price before reduction as the base. Select "none" if there is no effect.)

Before Price Reduction After Price Reduction Impact Sales price $380 $335 Quantity 6,000 7,000 Revenue $2,280,000 $2,345,000 $65,000 increase Variable manufacturing costs 990,000 1,155,000 165,000 increase Variable marketing costs 180,000 210,000 30,000 increase Contribution margin 1,110,000 980,000 130,000 decrease Fixed manufacturing costs 390,000 390,000 0 none Fixed marketing costs 450,000 450,000 0 none Income $270,000 $140,000 $130,000 decrease

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 $45,000 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 $3,040,000 $2,660,000 Variable manufacturing costs 1,320,000 1,155,000 Variable marketing costs 240,000 210,000 Contribution margin 1,480,000 $1,295,000 Fixed manufacturing costs 390,000 Fixed marketing costs 450,000 Income $640,000

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 $45 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 20 percent. What in-house unit cost should be used to compare with the quotation received from the supplier? Assume the payment to the outside contractor is $220. (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 $220 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 $455 each, while the costs of production would be $280 per unit variable manufacturing expense. Variable marketing costs would be $55 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? Assume the payment to the outside contractor is $220. (Round your answer to 2 decimal places.)

f-2. Should the proposal be accepted for a price of $220 per unit to the outside contractor?

	Accepted
	Not accepted

Answer 1

a-2 : No, I would not recommend taking this action since the income is deceasing with an increase in sales volume.

b)

	Without government contract	With Government Contract			Impact [Without govt contract - Total ]
		Regular	Government	Total		Increase/Decrease
Revenue	30,40,000	26,60,000	0	26,60,000	(3,80,000)	Decrease
Variable manufacturing costs	13,20,000	11,55,000	0	11,55,000	(1,65,000)
Variable marketing costs	2,40,000	2,10,000	0	2,10,000	(30,000)
Contribution margin	14,80,000	12,95,000	0	12,95,000	(1,85,000)	Decrease
Fixed manufacturing costs	3,90,000	3,90,000	0	3,90,000	0
Fixed marketing costs	4,50,000	4,50,000	0	4,50,000	0
Income	6,40,000	4,55,000	45000	5,00,000	(1,40,000)	Decrease

c. Minimum Selling price to be quoted:

Variable Materials	55
Variable Labor	80
Variable Overhead	30
Shipping Costs	45
Marketing Overhead ($2000/2000 units)	1
Minimum Sellling Price	211

d.Minimum selling price for obsolete items

Variable Materials	55
Variable Labor	80
Variable Overhead	30
Marketing Costs	30
Minimum Sellling Price	195