P7-1A Hyper Sports Inc. manufactures basketballs for the National Basketball Ass
ID: 2373926 • Letter: P
Question
P7-1A
Hyper Sports Inc. manufactures basketballs for the National Basketball Association
(NBA). For the first 6 months of 2011, the company reported the following operating
results while operating at 90% of plant capacity and producing 112,500 units.
Amount
Sales $4,500,000
Cost of goods sold 3,600,000
Selling and administrative expenses 450,000
Net income $ 450,000
Fixed costs for the period were: cost of goods sold $1,080,000, and selling and administrative
expenses $225,000.
In July, normally a slack manufacturing month, Hyper Sports receives a special order
for 10,000 basketballs at $28 each from the Italian Basketball Association (IBA). Acceptance
of the order would increase variable selling and administrative expenses $0.50 per
unit because of shipping costs but would not increase fixed costs and expenses.
Instructions
(a) Prepare an incremental analysis for the special order.
(b) Should Hyper Sports Inc. accept the special order? Explain your answer.
(c) What is the minimum selling price on the special order to produce net income of
$4.10 per ball?
(d) What nonfinancial factors should management consider in making its
decision?
Explanation / Answer
So first of it is important to know if the company has extra, unused capacities. Running at 90% of its capacity they produce a total of 112,500 units, so that means their maximum capacity is at 112,500*10/9 = 125,000 units, so they still can produce an extra 12,500 units. (enough!)
If we look at the total cost, that occur during production we get 3,600,000 + 450,00= 4,050,000. If we then divid it by the number of units produced, then we get the cost per unit:
4,050,000 / 112,500 = 36
So at the first glance it does not seem to make sense to accept the order because we have $36 in cost for each unit and we can only sell them for $28, which obviously would be a loss.
But in the text it is mentioned that the fixed cost would not increase due to the special order. So now you would have to break down the cost of goods sold and the admin costs into a variable and a fixed part:
cogs total: 3,600,000 = 32 per unit
fixed: 1,080,000 = 9.60 per unit
variable: 2,520,000 = 22.40 per unit
admin total: 450,000 = 4 per unit
fixed: 225,000 = 2 per unit
variable: 225,000 = 2 per unit
Total fixed cost per unit: 9.60 + 2 = $11.60
Total variable cost per unit : 22.40 + 2 = $24.40
It is given that the variable cost per unit will increase by $0.50, which means that our new total varaible costs are now $24.90.
So now if we accept the order, we will make an operating profit of $28 - $24.90 = $3.10 per unit.
If we want to make an operating profit of $4.10, then we will have to rise the selling price by $1 up to $29 per unit.
Such a special order should only be accepted if the maximum capacity has not been reached yet and if it is a one time only special deal. Because if they come again, they will only be willing to pay $28 per ball and not the required $36 per ball (to break even) which will kill your company in the long run.
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