Question

The Delmar Beverage Co. produces a premium root beer that is sold throughout its chain of restaurants in the Midwest. The company is currently producing 1,700 gallons of root beer per day, which represents 80% of its manufacturing capacity. The root beer is available to restaurant customers by the mug, in bottles, or packaged in six-packs to take home. The selling price of a gallon of root beer averages $14, and cost accounting records indicate the following manufacturing costs per gallon of root beer:

Raw materials	$	2.06
Direct labor		2.17
Variable overhead		2.11
Fixed overhead		2.03
Total absorption cost	$	8.37

In addition to the manufacturing costs just described, Delmar Beverage incurs an average cost of $1.05 per gallon to distribute the root beer to its restaurants.

  

SaveMore, Inc., a chain of grocery stores, is interested in selling the premium root beer in gallon jugs throughout its stores in the St. Louis area during holiday periods and has offered to purchase root beer from Delmar Beverage at a price of $11.00 per gallon. SaveMore believes it could sell 425 gallons per day. If Delmar Beverage agrees to sell root beer to SaveMore, it estimates the average distribution cost will be $1.52 per gallon.

   

Required:

a. Identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore? (Round your answers to 2 decimal places.)

      

b. How would Delmar Beverage’s daily operating income be affected by the acceptance of this offer? (Round your answer to 2 decimal places.)

      

Assume that Delmar Beverage is currently producing 2,125 gallons of root beer daily.

  

c-1. Identify all the relevant costs that Delmar Beverage should consider in evaluating the special sales order from SaveMore? (Round your answers to 2 decimal places.)

       

c-2. How would Delmar Beverage’s daily operating income be affected by the acceptance of this offer? (Round your answer to 2 decimal places.)

Answer 1

Answer:		( In gallons)
	Current production capacity	1,700
	Maximum production capacity	2,125	(1,700/80%)
	Spare capacity	425
a.	The relevant costs that Delmar Beverage should consider are as follows:
	Raw material	$                   2.06
	Direct Labor	$                   2.17
	Variable overhead	$                   2.11
	Distribution cost	$                   1.52
	Total relevant cost	$                   7.86	(Sum of all above)
b.	Contribution margin Income Statement
	Selling price	$                 11.00
	Less: Total relevant cost	$                   7.86
	Contribution margin per gallon	$                   3.14
	Number of gallon sold per day	425
	Total contribution margin	$            1,334.50	($3.14*425)
	Therefore, Delmar's daily net operating income would increase by $1,334.50
c-1	If the current production of Delmar Beverage is 2,125 gallons, it would would not have any spare capacity
	In this case relevant cost would be:
	Raw material	$                   2.06
	Direct Labor	$                   2.17
	Variable overhead	$                   2.11
	Distribution cost	$                   1.52
	Opportunity cost lost	$                   6.61	($14-2.06-2.17-2.11-1.05)
	Total relevant cost	$                 14.47	(Sum of all above)
c-2	Contribution margin Income Statement
	Selling price	$                 11.00
	Less: Total relevant cost	$                 14.47
	Contribution margin per gallon	$                  -3.47
	Number of gallon sold per day	425
	Total contribution margin	$          -1,474.75	($-3.47*425)
	Therefore, Delmar's daily net operating income would decrease by $1,474.75