Question

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows.

Materials	$	18.20
Labor		12.20
Variable overhead		5.20
Fixed overhead ($2,802,400 per year; 452,000 units per year)		6.20
Total	$	41.80

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 21,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $44 per pack. The regular selling price is $62. The special order would require some modification to the basic model. These modifications would add $4.20 per unit in material cost, $1.70 per unit in labor cost, and $0.70 in variable overhead cost. Although Fairmount has the capacity to produce the 21,000 units without affecting its regular production of 452,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $55,800 and would allow Fairmount to test up to 52,000 units.

Required:

a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont’s profits for the year.

b. Do you agree with the decision to accept the special order?

c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable.

Answer 1

a.

	Current sales	Proposed sales	Net effect on income
Sales	$62	$28,024,000(452,000*$62)		$28,948,000 ($28,024,000+(21,000*$44)	$924,000
Direct material	18.20	8,226,400 (452,000*$18.20)		8,696,800 (8,226,400+(21,000*22.4)	-470,400
Direct labor		5,514,400 (452,000*$12.20)		5,806,300 (5,514,400+(21,000*13.9)	-291,900
Variable overhead		2,350,400 (452,000*$5.20)		2,474,300 (2,350,400+(21,000*5.9)	-123,900
Contribution margin		11,932,800		11,970,600	37,800
Fixed cost		2,802,400		2,858,200 (2,802,400+55,800)	-55,800
Net operating income/(loss)		$9,130,400		$9,112,400	-$18,000

b. No

c.

Contribution margin per unit of special order:

Sales per unit	$44
Direct material per unit	-22.4
Direct labor per unit	-13.9
Variable overhead per unit	-5.9
Contribution margin per unit	$1.8

Minimum quantity of backpacks =Additional fixed cost / Contribution margin per unit

Minimum quantity of backpacks = $55,800 / $1.8 = 31,000 backpacks