Question

Drugs-R-Us, Inc., produces equipment for manufacturing drugs. The costs of manufacturing and marketing this equipment at the company's normal volume of 3,000 units per month are shown in Exhibit 1.

                                                          EXHIBIT 1 - Costs per Unit for Equipment

Unit manufacturing costs:

            Variable materials                                        $200

            Variable labor                                                 300

            Variable overhead                                        150

            Fixed overhead                                             240

                       Total unit manufacturing costs                                 $   890

Unit marketing costs:

            Variable                                                        $100

            Fixed                                                            280

                       Total unit marketing costs                                        $   380

Total unit costs                                                                                $1,270

The following questions refer only to the data given above. Unless otherwise stated, assume there is no connection between the situations described in the questions; each is to be treated independently. Unless otherwise stated, a regular selling price of $1,580 per unit should be assumed. Ignore income taxes and other costs that are not mentioned in Exhibit 1 or in the question.

1.   Market research estimates that monthly equipment production could be increased to 3,500 units which is well within production capacity limitations, if the price were cut from $1,580 to $1,400 per unit. Assuming the cost behavior patterns implied by the data in Exhibit 1 are correct, would you recommend that this action be taken? What would be the impact on monthly sales, costs, and income?

2.   Drugs-R-Us has an opportunity to enter a foreign market in which price competition is keen. An attraction of the foreign market is that demand there is greatest when demand in the domestic market is quite low; thus, idle production facilities could be used without affecting domestic business. Unlike many foreign markets there are no government restrictions. An order for 1,000 units is being sought at a below-normal price in order to enter this market. Additional shipping and handling costs for this order will amount to $150 per unit, while the cost of obtaining the contract (marketing costs) will be $8,000 in addition to the normal variable marketing costs. Domestic business would be unaffected by this order. What is the minimum (e.g. breakeven) unit price Drugs-R-Us should consider for this order of 1,000 units?

		Per Unit	Total	Relevant???
Variable Costs	Materials	$         200	$ 200,000
	Labor	$         300	$ 300,000
	Overhead	$         150	$ 150,000
	Marketing	$         100	$ 100,000
	Shipping	$         150	$ 150,000
Fixed Costs	Mfg OH	$         240	$ 240,000
	Marketing	$         280	$ 280,000
	Contract	$        8000	$     8,000

How can I fill out the Relevant???

How can I distinguish between relevant cost and irrelevant cost?

3.   An inventory of 230 units of equipment remains in the stockroom. These must be sold through regular channels at reduced prices or the inventory will soon be valueless. What is the minimum price that would be acceptable for selling these units?

Answer 1

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Drugs-R-Us
Current Income statement		Note
Quantity sold	3,000.00	A
Sell price	1,580.00	B
Variable materials	200.00
Variable labor	300.00
Variable overhead	150.00
Variable marketing costs	100.00
Variable costs	750.00	C
Contribution per unit	830.00	D=B-C
Contribution margin	2,490,000.00	E=A*D
Fixed overhead	240.00
Fixed marketing costs	280.00
Fixed costs	520.00	F
Total Fixed costs	1,560,000.00	G=F*A
Operating Income	930,000.00	H=E-G
Answer 1
Quantity sold	3,500.00	I
Sell price	1,400.00	J
Variable costs	750.00	See C
Contribution per unit	650.00	K=J-C
Contribution margin	2,275,000.00	L=K*I
Less: Total Fixed costs	1,560,000.00	See G
Operating Income	715,000.00	M=L-G

Decrease by

215,000.00

N=H-M

Answer 2	Per Unit	Total	Relevant	Remarks
Variable
Materials	200.00	200,000.00	Yes	It is an existing variable cost hence relevant.
Labor	300.00	300,000.00	Yes	It is an existing variable cost hence relevant.
Overhead	150.00	150,000.00	Yes	It is an existing variable cost hence relevant.
Marketing	100.00	100,000.00	Yes	It is an existing variable cost hence relevant.
Shipping	150.00	150,000.00	Yes	It is an incremental variable cost hence relevant.
Fixed
Mfg OH	240.00	240,000.00		It is a fixed cost hence sunk cost an irrelevant.
Marketing	280.00	280,000.00		It is a fixed cost hence sunk cost an irrelevant.
Contract	8,000.00	8,000.00	Yes	It is an incremental special order cost hence relevant.

Answer 3

Only Variable unit cost figure is relevant for setting a minimum selling price. Here as the units are valueless so company may incur only variable selling expenses. So relevant variable cost per unit will be- $ 100 i.e. variable marketing cost per unit.