Question

Sherene Nili manages a company that produces wedding gowns. She produces both a custom product that is made to order and a standard product that is sold in bridal salons. Her accountant prepared the following forecasted income statement for March, which is a busy month:

	Custom Dresses			Standard Dresses			Total
Number of dresses		10			20			30
Sales revenue	$	49,000		$	29,000		$	78,000
Materials	$	9,800		$	7,800		$	17,600
Labor		19,800			8,800			28,600
Machine depreciation		580			280			860
Rent		4,000			2,600			6,600
Heat and light		1,000			600			1,600
Other production costs								2,600
Marketing and administration								7,500
Total costs							$	65,360
Operating profit							$	12,640

Ms. Nili already has orders for the 10 custom dresses reflected in the March forecasted income statement. The depreciation charges are for machines used in the respective product lines. Machines depreciate at the rate of $1 per hour based on hours used, so these are variable costs. In March, cutting and sewing machines are expected to operate for 860 hours, of which 580 hours will be used to make custom dresses. The rent is for the building space, which has been leased for several years at $6,600 per month. The rent, heat, and light are allocated to the product lines based on the amount of floor space occupied.

A valued customer, who is a wedding consultant, has asked Ms. Nili for a special favor. This customer has a client who wants to get married in early April. Ms. Nili's company is working at capacity and would have to give up some other business to make this dress. She can't renege on custom orders already agreed to, but she can reduce the number of standard dresses produced in March to 10. Ms. Nili would lose permanently the opportunity to make up the lost production of standard dresses because she has no unused capacity for the foreseeable future. The customer is willing to pay $23,800 for the special order. Materials and labor for the order will cost $5,800 and $9,800, respectively. The special order would require 130 hours of machine time. Ms. Nili's company would save 140 hours of machine time from the standard dress business given up. Rent, heat and light, and other production costs would not be affected by the special order.

Required:

a-1. Calculate the differential operating profit (loss). (Select option "increase" or "decrease", keeping Without special order as the base. Select "none" if there is no effect.)

a-2. From an operating profit (loss) perspective for March, should Ms. Nili accept the order?

b. What is the minimum price Ms. Nili should accept to take the special order?

Answer 1

Part A 1

	Without special order	With special order	Impact
Revenue	78000	86850	8850	Increase
Materials	17600	19500	1900	Increase
Labor	28600	34000	5400	Increase
Machine depreciation	860	850	10	Decrease
Contribution margin	30940	32500	1560	Increase
Rent	6600	6600		None
Heat and light	1600	1600		None
Other production costs	2600	2600		None
Marketing and administration	7500	7500		None
Operating profit (loss)	12640	14200	1560	Increase

23800-(10*(29900/20)) = 11900

78000+8850 = 89900

5800-(10*(7800/20)) = 2900

17600+1900 = 19500

9800-(10*(8800/20)) = 5400

Depreciation = (130 hours-140 hours) * $1 = 10

Part A 2

Yes

Ms. Nili should accept the order because it increases operating profit by $1560

Part B

Minimum price

$22240

Minimum price = revenue from special order – additional contribution margin = 23800-1560 = $22240