Question

Ovation Company has a single product called a Bit. The company normally produces and sells 69,600 Bits each year at a selling price of $49 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	9.90
Direct labour		8.10
Variable manufacturing overhead		4.20
Fixed manufacturing overhead		3.00	($208,800 total)
Variable selling expenses		7.20
Fixed selling expenses		3.60	($250,560 total)
Total cost per unit	$	36.00

A number of questions relating to the production and sale of Bits follow. Each question is independent. Required: 1. Assume that Ovation Company has sufficient capacity to produce 104,400 Bits each year without any increase in fixed manufacturing overhead costs. The company could increase its sales by 25% above the current 69,600 units each year if it were willing to increase the fixed selling expenses by $111,000. 1 - a- Calculate the incremental net operating income. b- Would the increased fixed selling expenses be justified? Yes or No 2. Assume again that Ovation Company has sufficient capacity to produce 104,400 Bits each year. A customer in a foreign market wants to purchase 17,400 Bits. Import duties on the Bits would be $1.70 per unit, and costs for permits and licences would be $7,830. Both import duties and permits and licenses will be paid by Ovation. The only selling costs that would be associated with the order are $3.60 per unit shipping cost. Compute the per unit break-even price on this order. (Do not round your intermediate calculations. Round your answer to 2 decimal places.) 3. The company has 1,000 Bits on hand that have some irregularities and are therefore considered to be “seconds.” Due to the irregularities, it will be impossible to sell these units at the normal price through regular distribution channels. What unit cost figure is relevant for setting a minimum selling price?(Round your answer to 2 decimal places 4. Due to a strike in its supplier’s plant, Ovation Company is unable to purchase more material for the production of Bits. The strike is expected to last for two months. Ovation Company has enough material on hand to operate at 30% of normal levels for the two-month period. As an alternative, Ovation could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 60% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20%. What would be the impact on profits of closing the plant for the two-month period? (Input the amount as a positive value. Do not round your intermediate calculations.) 5. An outside manufacturer has offered to produce Bits and ship them directly to Ovation’s customers. If Ovation Company accepts this offer, the facilities that it uses to produce Bits would be idle; however, fixed manufacturing overhead costs would be reduced by 75%. Since the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their current amount. Compute the unit cost that is relevant for comparison to the price quoted by the outside manufacturer.(Do not round your intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Ovation Company

1a. calculation of incremental net operating income:

unit selling price	$49
Variable costs:
Direct material	$9.90
Direct labor	$8.10
variable manufacturing overhead	$4.20
variable selling expenses	$7.20
total variable cost per unit	$29.40
Unit contribution margin	$19.60
additional units of sale	17,400 units	(69,600 x 25%)
incremental contribution margin	$341,040
incremental costs -
selling expenses	$111,000
incremental net operating income	$230,040

1b. Yes, the increase in fixed expenses is justified as the incremental contribution margin is high enough to cover the increase in fixed selling expenses.

1. Computation of per unit break-even price for the special order:

Variable costs:
Direct material	$9.90
Direct labor	$8.10
variable manufacturing overhead	$4.20
variable selling expenses	$3.60
import duty	$1.70
total variable costs	$27.50
incremental fixed cost	$7,830

Per unit break-even price for the order –

At break-even sales,

Total revenue = total costs

Assuming the break-even price to be A,

17,400 x A = 27.50 x 17,400 + 7,830 = $486,330

A = 486,330/17,400 = $27.95

The break-even selling price for the special order is $27.95 per unit.

1. Determination of minimum selling price for the damaged units;

All the production costs (both variable and fixed) incurred in the production of units with irregularities are sunk costs. Also, the fixed selling expenses are not affected by the sale or no sale of these units. Hence, the only relevant cost is the variable selling expenses of $7.20.

Hence, the minimum selling price is $7.20

1. Determination of the amount of contribution margin foregone when the plant is closed down for 2 months:

Operating level for 2 months – 30% of normal production

= 30% of 69,600 = 20,880

Production loss = 48,720

Contribution loss on production loss = 48,720 x $19.60 = $954,912

Hence, if the plant operates at 30% of normal capacity fortwo months, the contribution loss = $954,912

If the plant is closed down for 2 months –

Savings in fixed manufacturing cost = 40% of $208,000 = $83,200

Savings in fixed selling costs= 20% of $250,560 = $50,112

Net financial disadvantage of closing the plant for two months = 954,112 – 83,200 – 50,112 = $821,600

assuming the company operates the plant for two months -

Contribution from 30% production = $19.60 x 20,880 units =$409,248

Total fixed cost –

Fixed manufacturing overhead$208,000

Fixed selling overhead$250,560458,560

Net loss $49,312

Comparison of the net loss from continuing production with the net disadvantage of closing the plant for two months,

Net operating loss on closing the plant for 2 months = $821,600

Net operating loss on continuing production at 30% for 2 months = $49,312

Since the relative loss on closing the plant is higher, the recommendation is to continue production at 30% normal capacity.

1. Determination of relevant costs –

1. Determination of the unit cost that is relevant for comparison to the price quoted by the outside manufacturer:

Variable manufacturing costs $22.20 (9.90 + 8.10 + 4.20)

Fixed manufacturing overhead $2.24 (208,000 x 75%) x 1/69,600

Variable selling expense $2.40($7.2 0x 2/3)

Total costs avoided$26.84

Hence, if the company purchases Bits from outside supplier, the unit cost relevant for comparison with outside quote by the external manufacturer would be the unit cost per Bit that can be avoided when the company purchases from outside, which equals to $26.84.