Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 30,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	600,000
Direct labor		6				180,000
Variable manufacturing overhead		3				90,000
Fixed manufacturing overhead		5				150,000
Variable selling expense		4				120,000
Fixed selling expense		6				180,000
Total cost	$	44			$	1,320,000

The Rets normally sell for $49 each. Fixed manufacturing overhead is $150,000 per year within the range of 22,000 through 30,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 22,000 Rets through regular channels next year. A large retail chain has offered to purchase 8,000 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 8,000 units. This machine would cost $16,000. 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 22,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 8,000 Rets. The Army would pay a fixed fee of $1.60 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 30,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 8,000 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	30,000.00
Sell price per unit			49.00	A
Direct Material		600,000.00	20.00
Direct Labor		180,000.00	6.00
Variable Manufacturing overhead		90,000.00	3.00
Variable selling expense		120,000.00	4.00	C
Total Variable cost per unit			33.00
Contribution per unit			16.00	G
Fixed Manufacturing overhead		150,000.00	5.00
Fixed selling expense		180,000.00	6.00
Total Fixed cost per unit			11.00
Current Scenario
Units Sold	22,000.00
Contribution earned		352,000.00
Less:
Fixed Manufacturing overhead		150,000.00
Fixed selling expense		180,000.00
Net Profit		22,000.00
Situation 1- Offer of Retail Chain
Reduction in Sell price by	16%
Reduction in Sell price per unit	7.84			B=A*16%
Reduction in Variable selling expense	75%
Reduction in Variable selling expense	3.00			D=C*75%
Revised Sell price per unit		41.16		E=A-B
Less:
Direct Material		20.00
Direct Labor		6.00
Variable Manufacturing overhead		3.00
Variable selling expense		1.00		F=C-D
Total Variable cost per unit		30.00
Contribution per unit		11.16
No. of Units		8,000.00
Total Contribution		89,280.00
Less: Cost of special machine		16,000.00
Net income		73,280.00

Conclusion: By selling the remaining 8,000 units Polaski Company can earn an additional profit $ 73,280. 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	1.60
Fixed manufacturing overhead per unit	5.00
Net received per unit	6.60
No. of Units	8,000.00
Total received	52,800.00

Conclusion: By selling the remaining 8,000 units to US army Polaski Company can earn an additional profit $ 52,800. So they should accept this project.

Situation 3- US Army
Particulars		Sales through regular channel	Provincial Government
Units Sold		30,000.00	22,000.00	H
Contribution earned		480,000.00	352,000.00	I=H*G
Less:
Fixed Manufacturing overhead		150,000.00	150,000.00
Fixed selling expense		180,000.00	180,000.00
Net Income		150,000.00	22,000.00
Add: Total received from US Army			52,800.00	Calculated in Situation 2 above
Net Profit		150,000.00	74,800.00
Variance			75,200.00

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 $ 75,200 less if it will sell to US Army.