Question

Cane Company manufactures two products called Alpha and Beta that sell for $150 and $105, respectively. Each product uses only one type of raw material that costs $5 per pound. The company has the capacity to annually produce 107,000 units of each product. Its unit costs for each product at this level of activity are given below:

	Alpha				Beta
Direct materials		$	30			$	10
Direct labour			25				20
Variable manufacturing overhead			12				10
Traceable fixed manufacturing overhead			21				23
Variable selling expenses			17				13
Common fixed expenses			20				15
Cost per unit		$	125			$	91

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are deemed unavoidable and have been allocated to products based on sales dollars.

5. Assume that Cane expects to produce and sell 100,000 Alphas during the current year. One of Cane's sales representatives has found a new customer that is willing to buy 15,000 additional Alphas for a price of $100 per unit. If Cane accepts the customer’s offer, it will decrease Alpha sales to regular customers by 8,000 units.

a. Calculate the incremental net operating income if the order is accepted

6 Assume that Cane normally produces and sells 95,000 Betas per year. If Cane discontinues the Beta product line, how much will profits increase or decrease?

8. Assume that Cane normally produces and sells 65,000 Betas and 85,000 Alphas per year. If Cane discontinues the Beta product line, its sales representatives could increase sales of Alpha by 20,000 units. If Cane discontinues the Beta product line, how much would profits increase or decrease?

Answer 1

5a. Incremental net operating income: $-288,000

	Existing customers-decrease Alphas (8000 units)		New customer- Alphas (15000 units)		Differential: Increase (Decrease) in net operating income
	Per unit $	Total $	Per unit $	Total $
Selling price	150	1200000	100	1500000	300000
Less: Variable costs
Direct materials	30	240000	30	450000	-210000
Direct labor	25	200000	25	375000	-175000
Variable manufacturing overhead	12	96000	12	180000	-84000
Variable selling expenses	17	136000	17	255000	-119000
Total variable costs	84	672000	84	1260000	-588000
Net operating income	66	528000	16	240000	-288000

The traceable fixed expenses and common fixed expenses are irrelevant as they will not change whether the Alphas are sold to existing customers or to a new customer.

6. Decrease in profits: $2,479,000

	Betas
Sales price per unit	105
Total variable costs per unit ($10 + $20 + $10 + $13)	53
Contribution per unit $	52
Number of units produced and sold	95000
Total contribution lost (95000 x $52)	4940000
Less: Savings in traceable fixed manufacturing overhead (107000 x $23)	2461000
Decrease in profits $	-2479000

The common fixed expenses are unavoidable and allocated costs which would continue to be incurred even if the product line is discontinued.

8. Profit increases by $401,000

	Discontinue Betas (65000 units)		Make Alphas (20000 units)		Differential: Increase (Decrease) in Profits
	Per unit $	Total $	Per unit $	Total $
Selling price	105	-6825000	150	3000000
Less: Variable costs
Direct materials	10	650000	30	600000
Direct labor	20	1300000	25	500000
Manufacturing overhead	10	650000	12	240000
Selling expenses	13	845000	17	340000
Total variable costs	53	3445000	84	1680000
Contribution margin	52	-3380000	66	1320000
Less: Savings in traceable fixed manufacturing overhead (107000 x $23)		2461000		0
Net increase / (decrease) in profits $		-919000		1320000	401000