Question

This is a special order problem that also requires that you use the high low method to estimate some cost function parameters, so you may want to review the high-low method lectures in Module 1. As with almost all of the analyses that we have done, determining variable and fixed costs, and knowing what to do with them, is critical. ______________________________________________________ Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 24,500 units of a power steering system component for $195 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.75 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market. Huang's production and cost information for the last two years for the component are as follows: 207,000 units 235,000 units Direct material costs $16,974,000 $19,270,000 Direct labor costs 4,657,500 5,287,500 Overhead costs 24,178,000 25,690,000 Selling and administrative costs 7,380,500 7,702,500 Total costs $53,190,000 $57,950,000 Total costs per unit $256.96 $246.60 T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $195 per unit offer is not only below the regular $250 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $220,000 and that Huang will have to lease some special equipment for $300,000. Required 1. Using the high-low method to determine cost behavior, what would the expected profit be on the special order (use a negative sign for a loss)?

Answer 1

1)

	At 207000 units	At 235000 units	Nature
Direct material	16974000/207000=82	19270000/235000= 82	variable
Direct labor	4657500/207000 = 22.5	5287500/235000= 22.5	variable
Overhead	24178000/207000= 116.80	25690000/235000=109.32	mixed   [neither constant in per unit nor in total)
Selling and administrative costs	7380500/207000= 35.65	7702500/235000=32.78	mixed

variable overhead cost =change in cos/change in units

            =[25690000-24178000]/[235000-207000]

         = 1512000/28000

          = $ 54 per unit

variable selling and administration cost = [7702500-7380500]/[235000-207000]

             = 322000/28000

              = $ 11.5 per unit

only variable cost is relevant in decision making since it varies with level of unit whereas fixed cost remain constant irrespective ofunit produced or sold so it is irrelevant

Revenue [24500*195]		4777500
;lesS:
Direct material [82*24500]	2009000
direct labor [22.5*24500]	551250
variable overhead [54*24500]	1323000
variable selling [11.5*24500]	281750
Shipping cost [2.75*24500]	67375
set up	220000
special equipment	300000
Total cost		(4779875)
profit /(loss)		2375