In: Finance
Solomon Company manufactures a personal computer designed for use in schools and markets it under its own label. Solomon has the capacity to produce 31,000 units a year but is currently producing and selling only 14,000 units a year. The computer’s normal selling price is $1,610 per unit with no volume discounts. The unit-level costs of the computer’s production are $480 for direct materials, $230 for direct labor, and $190 for indirect unit-level manufacturing costs. The total product- and facility-level costs incurred by Solomon during the year are expected to be $2,170,000 and $817,000, respectively. Assume that Solomon receives a special order to produce and sell 3,020 computers at $1,210 each.
a: What is the contribution to profit?
b. Should solomon accept or reject the offer?
Answer lead: | |||||||||
Solomon company's contribution i.e selling price minus variable costs will give an idea of contribution towards fixed costs. | |||||||||
Further, the company's spare capacity has to be analysed to decide on accepting or rejecting the special order | |||||||||
Inputs: | |||||||||
Maximum yearly capacity | 31000 | ||||||||
Current annual production | 14000 | ||||||||
Selling price per unit- SP | $1610 | ||||||||
Direct materials cost per unit- DM | $480 | ||||||||
Direct labour cost per unit- DL | $230 | ||||||||
Indirect unit level manufacturing cost per unit-IDL | $190 | ||||||||
Yearly product level costs | $2,170,000 | ||||||||
Yearly facility level costs | $817,000 | ||||||||
Special order selling price | $1210 | ||||||||
Special order quantity - units | 3020 | ||||||||
Working: | |||||||||
a) Contribution to profit: | |||||||||
Contribution per unit= | Selling price- Variable costs | ||||||||
Variable costs in $ | DM+DL+IDL | ||||||||
900 | |||||||||
Special order selling price in $ | 1210 | ||||||||
Contribution per unit in $= | 1210-900 | ||||||||
310 | |||||||||
Total contribution to profit in $= | Contribution per unit * Special order quantity | ||||||||
310*3020 | |||||||||
936200 | |||||||||
Special order's Contribution to profit in $ | 936200 | ||||||||
b) Solomon company's decision: | |||||||||
Idle capacity= | Maximum capacity- current production | ||||||||
31000-14000 | |||||||||
Yearly Idle capacity in units | 17000 | ||||||||
Solomon can accept the special order because he has idle capacity to produce 3020 units. | |||||||||
Further, the special order gives $936,200 as contribution towards profit. | |||||||||
This contribution can be used by Solomon company towards their recovery of fixed costs namely product level costs & facility level costs.. |