Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 40,000 Rets per year. Costs associated with this level of production and sales are given below:

  

	Unit			Total
Direct materials	$	20		$	800,000
Direct labor		8			320,000
Variable manufacturing overhead		3			120,000
Fixed manufacturing overhead		7			280,000
Variable selling expense		4			160,000
Fixed selling expense		6			240,000
Total cost	$	48		$	1,920,000

   

The Rets normally sell for $53 each. Fixed manufacturing overhead is constant at $280,000 per year within the range of 33,000 through 40,000 Rets per year.

  

Required:
1.	Assume that due to a recession, Polaski Company expects to sell only 33,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 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 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

     

2.

Refer to the original data. Assume again that Polaski Company expects to sell only 33,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 7,000 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. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

     

3.	Assume the same situation as that described in (2) above, except that the company expects to sell 40,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 7,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 7,000 Rets were sold through regular channels?

     

Answer 1

1)	Incremental Sales revenue (7000*$53*84%) =	$    3,11,640
	Incremental variable cost of production = 7000*(20+8+3) =	$   -2,17,000
	Incremental variable selling expenses = 7000*$4*25% =	$         -7,000
	Incremental capital expenditure (one time with no salvage value)	$      -14,000
	Increase in profits if the special order is accepted	$        73,640
2)	Revenue from the order:
	Reimbursement of costs of production at $31 per unit + Fixed overhead cost per unit of $7+ Fixed fee of $1.80 per unit = 7000*(31+7+1.80) =	$    2,78,600
	Less: Variable cost of production = 7000*$31=	$    2,17,000
	Net increase in profits	$        61,600
3)	Revenue from the order from the Army (as above)	$    2,78,600
	Revenue if sold through regular channels = 7000*$53 =	$    3,71,000
	Decrease in revenue	$        92,400
	Less: Variable selling expenses avoided if Army's order is accepted = 7000*4*75% =	$        21,000
	Net decrease in profit if the Army's order is accepted	$        71,400