Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 26,500 units of a power steering system component for $197 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.75 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market.

To determine variable and fixed costs, Huang's accountant used the high-low method with the following production and cost information for the last two years:

	204,000 Units	225,000 Units
Total Costs	$55,340,000	$59,225,000
Total Costs Per Unit	$271.27	$263.22

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $197 per unit offer is not only below the regular $250 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $255,000 and that Huang will have to lease some special equipment for $250,000.

Question: Using the high-low method to budget costs of the special order, what would the expected profit on the special order be (use a negative sign for a loss)?

Answer 1

Statement of Additional Benefit from Special Order(26500 units)
Particulars	Total
Sales(26500*197)	5,220,500
Less: Variable Costs(26500*185)	(4,902,500)
Additional Shippinh cost(26500*2.75)	(72,875)
Additional Set up Costs	(255,000)
Leasing cost	(250,000)
Expecting Loss on Special Order	(259,875)

Calculation of V.C. per unit using High Low Method:

Variable Cost (p.u)= (Highest Activity Cost-Lowst Activity Cost)/(Highest Activity Units-Lowest Activity Units)

variable Cost(p.u)=(59225000-55340000)/(225000-204000)

VC(p.u)=38,85,000/21,000

VC(p.u)= 185

Fixed Costs=Total Cost At Higher Activity-(VC(p.u)*Highest Activity Units)

Fixed Costs=59225000-(185*225000)

fixed costs= 1,76,00,000