Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 44,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	880,000
Direct labor		8				352,000
Variable manufacturing overhead		3				132,000
Fixed manufacturing overhead		5				220,000
Variable selling expense		4				176,000
Fixed selling expense		6				264,000
Total cost	$	46			$	2,024,000

The Rets normally sell for $51 each. Fixed manufacturing overhead is $220,000 per year within the range of 36,000 through 44,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 36,000 Rets through regular channels next year. A large retail chain has offered to purchase 8,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 8,000 units. This machine would cost $16,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 36,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 8,000 Rets. The Army would pay a fixed fee of $1.40 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 44,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 8,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

Polaski Company

	Financial Advantage /(disadvantage)
Situation 1	$70,720
Situation 2	$11,200
Situation 3	($116,800)

Computations:

Given information for 36,000 units of Ret:

                                                                        Per Unit                       Total

Variable costs –

Direct materials                                               $20.00                         $720,000                    

Direct labor                                                     $8.00                           $288,000

Variable manufacturing overhead                   $3.00                           $108,000

Variable selling expense                                  $4.00                           $144,000

Total variable costs                                         $35.00                         $1,260,000

Fixed costs –

Manufacturing overhead                                                                     $220,000

Selling overhead                                                                                 $264,000

Total fixed cost                                                                                   $484,000

Situation1:

Analysis of the financial advantage of the special order for 8,000 units:

Selling price = $51 – 16% of 51 = $42.84

Decreased variable selling expenses =$4- $4 x 75% = $1

Revised variable cost = $35 -$4 +$1 = $32

Revised contribution margin = $42.84 - $32 = $10.84 per unit

Contribution margin for 8,000 Rets = 8,000 x $10.84 = $86,720

Less: incremental fixed costs              $16,000

Net financial advantage of the special order for 8,000 Rets = $86,720 - $16,000 = $70,720

Situtaion2:

One time purchase by the US Army:

Analysis of the accepting the order to produce and sell 8,000 units of Ret to the US Army:

Price per unit                                       $1.40

Since the Army would cover all the variable and fixed costs of production and no selling expenses are likely to be incurred, the financial advantage to Polaski would be $11,200 (1.40 x 8,000 Rets).

So, if Polaski accepts the US Army proposal, the company’s profits would increase by $11,200 per year.

Since all production costs (variable and fixed) are reimbursed by the US Army, those costs are not considered to determine the incremental revenue.

The variable selling expenses are avoided, and hence are not included.

Though the fixed selling expenses are incurred, they are irrelevant for the decision, as these costs are incurred regardless of the decision to sell Rets to the US Army.

Hence, the financial advantage of accepting the US Army special order is $11,200.

Situation3

Giving up regular sales of 8,000, would indicate to following outcomes,

Financial advantage of accepting the special order from the US Army         $11,200

Less: Loss of contribution margin = ($51-35) x 8,000 = 8,000 x $16 per Ret = $128,000

Net financial disadvantage of accepting the special order from the US Army is $116,800.