Question

Grant Industries, a manufacturer of electronic parts, has recently received an invitation to bid on a special order for 25,000 units of one of its most popular products. Grant currently manufactures 50,000 units of this product in its Loveland, Ohio, plant. The plant is operating at 50% capacity. There will be no marketing costs on the special order. The sales manager of Grant wants to set the bid at $14 because she is sure that Grant will get the business at that price. Others on the executive committee of the firm object, saying that Grant would lose money on the special order at that price.

Units		50,000		75,000
Manufacturing costs:
Direct materials	$	200,000	$	300,000
Direct labor		250,000		375,000
Factory overhead		350,000		450,000
Total manufacturing costs	$	800,000	$	1,125,000
Unit cost	$	16	$	15

Required

2. What would be the Relevant cost per unit if the order is accepted at the price recommended by the sales manager? What do you think the minimum (short-term) bid price should be?

4. What would the total opportunity cost be if by accepting the special order the company lost sales of 6,800 units to its regular customers? Assume the preceding facts plus a normal selling price of $30 per unit.

Answer 1

2)	Relevant costing helps us to compute the incremental costing for decision making
	To compute relevant cost mentioned in the question, we need to calculate the incremental costs by comparing the costs at both 50,000 capacity and 75,000 capacity
		50,000 capacity (a)	75,000 capacity (b)	Incremental cost (b)-(a)
	Direct Material	$                         200,000	$                                                                300,000	$                              100,000
	Direct Labor	$                         250,000	$                                                                375,000	$                              125,000
	Factory o/h	$                         350,000	$                                                                450,000	$                              100,000
			Additional Cost for manufacturing 25,000 units	$                              325,000
		Therefore, relevant cost per unit (325,000/25,000)	Therefore, relevant cost per unit (325,000/25,000)	$                                         13
	Hence, the minimum bid price for this order is $13 where there in no loss to the Company. Any price above $13 will increase in incremental profit
4)	Opportunity cost is the cost of selecting one alternative over the other
	Calculation of opportunity cost: Contribution margin forgone by accepting special order less incremental profit of special order
	Opportunity cost of accepting special order ($142,800 - $25,000)			$                              117,800
	Contribution margin:		Selling price less variable cost
			Selling price per unit (a)	$                                         30
			Variable cost per unit
			Direct Cost (50,000 units)	$                              200,000
			Direct Labor (50,000 units)	$                              250,000
			Total variable cost	$                              450,000
			Variable cost per unit (b)	$                                           9
	Therefore contribution margin		(a)-(b)	$                                         21
	Contribution margin on 6,800 units		Margin*6,800	$                              142,800
	Incremental profit from special order
			Incremental revenue ($14*25,000 units)	$                              350,000
			Incremental cost (calculated above)	$                              325,000
			Therefore, incremental profit	$                                 25,000