Problem 9-5 Determining Whether to Accept or Reject a Special Order (LO1 - CC5)

Question

Problem 9-5 Determining Whether to Accept or Reject a Special Order (LO1 - CC5) Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 56,000 Rets per year. Costs associated with this level of production and sales are as follows: Unit 17.50 12.50 Total Direct materials Direct laboun Variable manufacturing $24.50 $1,372,000 980,000 700,000 overhead Fixed manufacturing overhead Variable selling expense Fixed selling expense 18.50 4.00 6.00 1,036,000 224,000 336,000 Total cost $83.00$4,648,000 The Rets normally sell for $88 each. Fixed manufacturing overhead is constant at $1,036,000 per year within the range of 32,000 through 56,000 Rets per year Required 1. Assume that, due to a recession, Polaski Company expects to sell only 32,000 Rets through regular channels next year. A large retail chain has offered to purchase 24,000 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 24,000 units. This machine would cost $48,000. Polaski Company has no assurance that the retail chain will purchase additional units any time in the future. Determine the impact on profits next year if this special order is accepted in profits

Explanation / Answer

1) New contribution margin Selling price   88*(1-.16) 73.92 less :Variable expense Direct materials 24.5 Direct labor 17.5 variable manufacturing overhead 12.5 variable selling expense (4*25%) 1 total variable expense 55.5 -55.5 New contribution margin 18.42 total contribution margin (24000*18.42) 184200 less :cost of machine -48,000 Net income 136200 Net profit increases by 136,200 2) Fixed fee 3.4 Fixed manufacturing overhead reimbursed 18.5 total 21.9 total contribution   24000*21.9 525600 Net profit increase by 525,600 (note though VMOH is also reimbursed ,it is not considered as the same amount will be incurred in production also) 3) original contribution margin per unit Selling price   88 less :Variable expense Direct materials 24.5 Direct labor 17.5 variable manufacturing overhead 12.5 variable selling expense 4 total variable expense 58.5 -58.5 New contribution margin 29.5 contribution lost (24000*29.50) -708000 income from Army order 525,600 Net loss -182400 Net profit will decrease by -182400 financial disadvantage 182,400 answer

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