Question

Old Vine Vineyard produces premium wine. Its success in the industry is due to its quality, although all of its customers, wine shops and specialty grocery stores, are very cost conscious and negotiate for price cuts on all large orders. Noting that the wine industry is becoming increasingly competitive, Old Vine is looking for a way to meet the challenge. It is negotiating with Eastern Seasons, a regional specialty grocery store, to purchase a large order of wine. Old Vine is currently producing at under-capacity and would like to keep its production facilities, gaining better economies of scale by increasing production. Eastern Seasons has agreed to a large order but only at a price of $31 per bottle. The special order can be purchased in one batch with available capacity. Old Vine prepared these data:

Next month's operating information (per unit, for 10,000 bottles, made in 10 batches of 1,000 each):

Sales Price                                                                               $45

Per Unit costs:

Variable manufacturing costs                                        16

Batch level costs                                                           4

Variable marketing costs                                               9

Fixed manufacturing costs                                            6

Fixed marketing costs                                                   1

Special order information – order is produced in one batch

            Sales units                                                                   2,000

            Sales price per bottle                                                     $31

No variable marketing costs are associated with this order, but Old Vine has spent $2,500 during the past two months trying to get Eastern Seasons to purchase the special order.


A. How much will the special order change Old Vine's total operating income?

B. How much would the special order change Old Vine's total operating income if Old Vine is operating at full capacity and would lose the sale of the 2,000 bottles to regular customers?

C. How might the special order fit into Old Vine's competitive strategy?

Answer 1

Solution

A.

special order will cause one new batch.one batch cost is $4,000(1000×$4).

Relevant costs per unit for special order:

Variable manufacturing costs=$16

Batch related costs($4,000/2000 units)=$2

Total unit relevant cost for special order=$18 per unit

Total relevant cost for special order=$18×2000 units

=$36,000

Total revenue from special order(2000×$31)=$62,000

Total relevant cost for special order=$36,000

Change in Old wine's total operating income (62000-36000)=$26,000

2.

*Contribution of special order{($31-$16)×2,000}=$30,000

Lost contribution on loss of regular sales{($45-$16-$9)×2,000}=$40,000

Net loss of special order under full capacity=(10,000)

*Here batch level costs are irrelevant as the special order will loose the regular sales . total units ordered will be 10,000 units whether special order is accepted or not. Batch level cost will be the same , with or without special order.

3. Special order will help the company to get the lowered overall cost and help in becoming cost competitive. Special order help the company to get new customers and increase in sales also