Question

Gamma Company manufactures soft drinks. Its manufacturing plant has the capacity to produce 10,000 cases each month; current production and sales are 7,500 cases per month. The company normally charges $150 per case. Cost information for the current activity level is as follows:

Variable costs that vary with units produced

Direct materials ---------------------------------------------$ 262,500

Direct manufacturing labour -------------------------------- 300,000

Variable costs (for setups, materials handling, quality control, and so on) that vary with number of batches, 150 batches x $500 per batch ---------------------------------------75,000

Fixed manufacturing costs ------------------------------------275,000

Fixed marketing costs -----------------------------------------175,000 T

otal costs ---------------------------------------------------$ 1,087,500

Gamma Company has just received a special one-time-only order for 2,500 cases at $100 per case. Gamma Company usually makes its soft drinks for its existing customers in batch sizes of 50 case (150 batches x 50 cases per batch = 7,500 cases). The special order requires them to make the cases in 25 batches of 100 each.

Required:

(a) Should Gamma Company accept this special order? Why? Explain briefly.

(b) Suppose plant capacity was only 9,000 cases instead of 10,000 cases each month. The special order must either be taken in full or rejected totally. Should Gamma Company accept the special order?

(c) As in requirement (a) assume that monthly capacity is 10,000 cases. Gamma Company is concerned that if it accepts the special order, its existing customers will immediately demand a price discount of $10 in the month in which the special order is being filled. They would argue that Gamma Company capacity costs are now being spread over more units, and that existing customers should get the benefit of these lower costs. Should Gamma Company accept the special order under these conditions? Show all calculations.

Answer 1

incremental analysis
Incremental sales revenue (2500*100)				250000
Less: Incremental expensses
Direct material (262500/7500 *2500)				52500
Labour (300000/7500*2500)				100000
Variable cost (25*500)				12500
Net income				85000
Yes, the order must be accepted
Incremental analysis
Incremental sales revenue (2500*100)				250000
Less: Incremental expensses
Direct material (262500/7500 *2500)				52500
Labour (300000/7500*2500)				100000
Variable cost (25*500)				12500
Loss of contribution of 1000 units				88000
(1000*150 - 21000-40000-1000)
Net loss				-3000
Order must be rejected
Incremental analysis
Incremental sales revenue (2500*100)				250000
Less: Incremental expensses
Direct material (262500/7500 *2500)				52500
Labour (300000/7500*2500)				100000
Variable cost (25*500)				12500
Loss of contribution from existing customer				75000
(7500*10)
Net Income				10000
Order must be accepted