Question

Mohave Corp. makes several varieties of beach umbrellas and accessories. It has been approached by a company called Lost Mine Industries about producing a special order for a custom umbrella called the Ultimate Shade (US). The special-order umbrellas with the Lost Mine Company logo would be distributed to participants at an upcoming convention sponsored by Lost Mine. Lost Mine has offered to buy 3,500 of the US umbrellas at a price of $36 each. Mohave currently has the excess capacity necessary to accept the offer. The following information is related to the production of the US umbrella:   

Direct materials	$	15.00
Direct labor		8.00
Variable manufacturing overhead		11.00
Fixed manufacturing overhead		2.50
Total cost	$	36.50
Regular sales price	$	44.00

1. Compute the incremental profit (or loss) from accepting the special order.

Profit (or Loss)

by

2. Should Mohave accept the special order?

3. Suppose that the special order had been to purchase 4,000 umbrellas for $33.00 each. Recompute the incremental profit (or loss) from accepting the special order under this scenario.

Profit(or Loss)

by

4. Assume that Mohave is operating at full capacity. Calculate the special-order price per unit at which Mohave would be indifferent between accepting or rejecting the special order.

Special Order Price

per Unit

Answer 1

The Order of customized US umbrella by Lost Mine Company is a special order for Mohave Corp. Absorption costing technique would not be applied here since this is not a normal or routine order.

Solution 1: Profit of $7000

To reach at the incremental profit, relevant cost needs to be computed for customized umbrella.

It should be noted that Fixed manufacturing overhead will remain same in total hence would be treated as irrelevant cost to accept this order.

Total relevant cost per unit= Material cost+ labor cost+ Variable manufacturing Overhead

= 15 + 8+ 11

= $34

Lost mine has asked for the order of 3500 US umbrellas at $36, total profit would be 3500 * (36 – 34) = $7000

Solution 2: Yes

Mohave should accept the order since it gets additional profit of $7000.

Solution 3: Loss of $3500

Relevant cost is $34 per umbrella. Lost mine has asked for the order of 3500 US umbrellas at $33, total loss would be 3500 * (33 – 34) = ($3500)

Solution 4: $44

If Mohave is running at full capacity and still have to accept the order, it will have to recover the total of all the variable cost to be spent + opportunity cost (contribution lost from orders foregone).

In short, it will ask for minimum regular sales price of $44.