Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 30,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	15			$	450,000
Direct labor		8				240,000
Variable manufacturing overhead		3				90,000
Fixed manufacturing overhead		9				270,000
Variable selling expense		4				120,000
Fixed selling expense		6				180,000
Total cost	$	45			$	1,350,000

The Rets normally sell for $50 each. Fixed manufacturing overhead is $270,000 per year within the range of 25,000 through 30,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 25,000 Rets through regular channels next year. A large retail chain has offered to purchase 5,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 5,000 units. This machine would cost $10,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order?

2. Refer to the original data. Assume again that Polaski Company expects to sell only 25,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 5,000 Rets. The Army would pay a fixed fee of $1.80 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 30,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 5,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1)	New contribution margin
	Selling price		50*(1-.16)			42
	less :Variable expense
	Direct materials				15
	Direct labor				8
	variable manufacturing overhead				3
	variable selling expense			(4*25%)	1
	total variable expense				27	-27
	New contribution margin					15
	total contribution margin			(5000*15)		75000
	less :cost of machine					-10,000
	Net income					65000
	financail advantage			65,000
	net profit increase by $61200
2)	Fixed fee				1.8
	Fixed manufacturing overhead reimbursed				9
	total				10.8
	total contribution		5000*10.8		54000
	financial advantage		54,000
	net profit increases by $50,400
	(note though VMOH is also reimbursed ,it is not considered as the same amount
	will be incurred in production also)
3)	original contribution margin per unit
	Selling price					50
	less :Variable expense
	Direct materials				15
	Direct labor				8
	variable manufacturing overhead				3
	variable selling expense				4
	total variable expense				30	-30
	New contribution margin					20
	contribution lost		(5000*20)			-100000
	income from Army order					54,000
	Net loss					-46000
	Net profit will decrease by			-46000
	financial disadvantage			46,000	answer