Question

GEM Limited has a single product Flicks. The company normally produces and sells 80,000 units of Flicks each year at a price of $240 per unit. The company’s unit costs at this level of activity are as follow: Direct material Direct labour Variable manufacturing overhead Fixed manufacturing overhead Variable selling and administrative costs Fixed selling and administrative costs Total unit cost $57.00 60.00 16.80 30.00 10.20 27.00 $201.00 GEM has sufficient capacity to produce 100 000 units of Flicks a year without any increase in fixed manufacturing overhead. Required: (a) GEM has an opportunity to sell 10 000 units to an overseas customer. Import duties and other special costs associated with this order would total $42 000. The only selling costs that would be associated with the order would be a shipping cost of $9.00 per unit. What would be the minimum acceptable unit price for GEM to consider this order? (hint: GEM would not accept the order if it would reduce the company’s profit) (b) The company has 200 units of Flicks on hand that were produced two months ago. Due to blemishes on the units, it will be impossible to sell these units at the normal price. If the company wishes to sell them through regular sales channels, what would be the relevant cost for setting the minimum price? Explain. (c) “All future costs are relevant in decision making.” Do you agree?

Answer 1

In the problem given first we work out the normal profitability so that to work out the minimum price for import order so that the profitability is maintained .

	GEM LTD
			(Amount in $)	(Amount in $)
	Selling Units	80,000
	Price Per Unit ($)	240
	Total Sales Value (A)			19,200,000
	Direct Material	57	4,560,000
	Direct Labour	60	4,800,000
	Variable Manufacturing overheads	16.8	1,344,000
	Variable selling and administrative costs	10.2	816,000
	Total Variable cost (B)			11,520,000
	Fixed manufacturing overheads	30	2,400,000
	Fixed selling and administrative costs	27	2,160,000
	Total Fixed Cost(c )			4,560,000
	Total Cost D=(B-C)			16,080,000
	Net Income (A-D)			3,120,000
				16.25
	Thus Selling price for Export order to be fixed minimum @ 187.7 so as to maintain the same level of profitability
	Import Order
			(Amount in $)
	Selling Units	10000
	Price Per Unit ($)	187.70	1877015
	Total Sales Value (A)
	Direct Material	57	570000
	Direct Labour	60	600000
	Variable Manufacturing overheads	16.8	168000
	Variable selling and administrative costs	10.2	102000
	Shipping cost	9	90000
	Total Variable cost (B)	153	1530000
	Import duty		42000
	TOTAL Cost		1572000
			305,015
	Normal profit Rate		16.25
	Cost to be	83.75	100
	Thus if we rounded off the cost to derive the sale price
	cost /83.75 * 100		1,877,015
	Units		10000
	Sale price to achieve the same level of profitability		187.70
B)	200 units with blamish cant sale in normal prices
	as its normal loss then the cost of these units are absorbed by the good units .
	thus the cost of this units will be Zero
	if we are planning to dispose off through normal sale channel then it is advisable to recover atleast the material cost minimum and full variable cost if possible

The Statement all future costs are relevant in decision making is false . not all future costs are relevant for decision making . only those costs will vary if different alternative options are relevant . if they remain the same then it's not relevant .