Question

Gruden Company produces Golf discs, which it normally sells to retailers for $7 each. the cost of manufacturing 20,000 golf discs is:

materials                            10,000

labour                                 30,000

varible overhead                20,000

fixed overhead                   40,000

total                                  100,000

Gruden also incurs %5 sales comission (0.35) on each disc sold.

McGee corporation offers Gruden $4.80 per disc for 5000 discs. McGee would seel the discs under is own brnd name in foreign markets not yet serviced by Gruden. If Gruden accpets the offer, its fixed overhead will increase from 40000 to 46000 die to the purchase of a new imprinting machine no sales commission will result from the special order.

a) prepare an incremental analysis for the special order

b) should Gruden accept the special order? why or why not?

c) what assumptions underlie the decision made in part b)?

d)Assume that McGee Corporation will not settle for anything less than 5,000 discs.However, to be able to fulfill this size of order, Gruden would have to forego 500 units of regular priced sales.Given this, what is the minimum price Gruden would need to receive from McGee to be indifferent profit wise (i.e., the same profit for each alternative under consideration)?Should Gruden still accept the special order?

Hint: recall the minimum selling price formula in day 1 that involves incorporating an opportunity cost in special pricing decisions.Perhaps the easiest way to tackle this question is to conduct the calculation on a total cost basis and then divide by 5,000 units to obtain the per unit selling price.

Answer 1

Gruden Company
Incremental analysis for special order
Contribution margin from special order of Mcgee corporation
=	(4.80-3)*5000		9000
Less : additional fixed cost to be incurred			6000
Net operating income from special order			3000
Yes, as there is positive net operating income from this order
Gruden should accept the order
Contribution forgone on 500 discs
=500*(7-3)			2000
Number of discs of special order			5000
Contribution forgone per disc			0.4
Original price envisaged by Mcgee corporation			4.8
Minimum price gruden would need to receive to be indifferent profit wise			5.2
Alternatively, we can find the above minimum price in the following way
Contribution forgone on 500 discs
=500*(7-3)			2000
Net operating Income(same profit on special order)			3000
Variable cost of 5000 discs			15000
Additional fixed cost to be incurred			6000
Total costs including opportunity cost			26000
Number of discs of special order			5000
Minimum price gruden would need to receive to be indifferent profit wise			5.2

As regards the assumption in part c), it is assumed that Gruden would not sell the discs in foreign market served by Mcgee under its own brand name and thus allowing Mcgee to do the same. However,. Had Gruden wants to start selling the discs in the foreign market under its own brand name, it may find difficulties