Question

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows:

Materials $ 18.30

Labor 12.30

Variable overhead 5.30

Fixed overhead ($2,853,900 per year; 453,000 units per year) 6.30

Total $ 42.20

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 22,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $45 per pack. The regular selling price is $63. The special order would require some modification to the basic model. These modifications would add $4.30 per unit in material cost, $1.80 per unit in labor cost, and $0.80 in variable overhead cost. Although Fairmount has the capacity to produce the 22,000 units without affecting its regular production of 453,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $70,400 and would allow Fairmount to test up to 53,000 units.

Required:

a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont’s profits for the year.

b. Do you agree with the decision to accept the special order?

	Yes
	No

c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable.

Answer 1

(a).

	(All Costs in Thousands of Dollars)
	Status Quo 453000 units	Alternative 475000 units	Difference
Sales revenue	$28539	$29529	$990	Higher
Less: Variable costs;				Higher
Materials	$8289.9	$8787.1	$497.2	Higher
Labor	$5571.9	$5882.1	$310.2	Higher
Variable overhead	$2400.9	$2535.1	$134.2	Higher
Total variable cost	$16262.7	$17204.3	$941.6	Higher
Contribution margin	$12276.3	$12324.7	$48.4	Higher
Less: Fixed costs	$2853.9	$2924.3	$70.4	Higher
Operating profit (Loss)	$9422.4	$9400.4	($22)	Lower

(b).

Answer is (NO)

Explanation;

As we have seen in part (a) that after accepting special order total operating profit have been declined, so we will not accept this speecial order.

(c). 32000 units

Explanation;

Let’s calculate break-even point for knowing the minimum quantity of backpacks in the special order that would make it profitable;

Incremental fixed costs = $70400

Incremental contribution margin per unit ($48400 / 22000) = $2.2

Break-even point will be;

$70400 / $2.2 = 32000 units