Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 40,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	800,000
Direct labor		6				240,000
Variable manufacturing overhead		3				120,000
Fixed manufacturing overhead		9				360,000
Variable selling expense		4				160,000
Fixed selling expense		6				240,000
Total cost	$	48			$	1,920,000

The Rets normally sell for $53 each. Fixed manufacturing overhead is $360,000 per year within the range of 34,000 through 40,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 34,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 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 6,000 units. This machine would cost $12,000. 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 34,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.20 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 40,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1 )Financial Advantage of accepting the Retail Chain order :$ 75120 ( see working notes 1 and 2 below)

Working Note:

1. Financial Advantage /(Disadvantage) of accepting the order :

Particulars	Per unit ($ )	Per unit ($ )	Total($ )
Selling Price per unit ($53*0.86)		$ 44.52
Less: Variable Cost
Direct material	$ 20
Direct Labour	$6
Variable Manufacturing Overhead	$ 3
Variable Selling Expenses	$ 1	$ 30
Contribution Per Unit		$14.52
Number of units		6000
Total contribution		$ 87120
Less: Specific Fixed Cost(working note 2)		$ 12000
Profit on the order		$ 75120

2. The special order needs a machine that costs $12000. These costs are specific to the retail chain order. Polaski Company has no assurance that the retail chain will purchase additional units in the future and therefore it is best to set it off against this current order itself.

2 ) Financial Advantage of accepting the U.S Army’s order= $ 61200

Working Note:

The U.S army has made an offer to purchase the 6000 units by paying a fee of $1.20/unit plus Reimbursement of all variable production costs and Fixed Production Costs associated with the units. No variable selling costs on this order.

Financial Advantage to the company= Fixed fee of $1.20/unit+ Reimbursement of Fixed Costs

                                                                  =$1.20*6000 units+$3,60,000*6000/40000= $ 61200

3) Financial Disadvantage of accepting the U.S Army’s order=( $ 58,800 )

Working Note:

Since the company is able to sell 40000 units and if it accepts the U.S Army special order

Financial Advanntage/(Disadvantage)=Fixed Fee of $1.20/unit+ Reimbursement of Fixed Costs-opportunity cost involved(i.e loss of contribution from loss of sale of 6000 units to the market)

= $ 7200+$ 54000-$($20*6000)=$ 61200-$ 120000= ($ 58,800)