Question

Green Grow Inc. (GGI) manufactures lawn fertilizer. Because of the product’s very high quality, GGI often receives special orders from agricultural research groups. For each type of fertilizer sold, each bag is carefully filled to have the precise mix of components advertised for that type of fertilizer. GGI’s operating capacity is 22,000 one-hundred-pound bags per month, and it currently is selling 20,000 bags manufactured in 20 batches of 1,000 bags each. The firm just received a request for a special order of 5,000 one-hundred-pound bags of fertilizer for $130,000 from APAC, a research organization. The production costs would be the same, but there would be no variable selling costs. Delivery and other packaging and distribution services would cause a one-time $2,500 cost for GGI. The special order would be processed in two batches of 2,500 bags each. (No incremental batch-level costs are anticipated. Most of the batch-level costs in this case are short-term fixed costs, such as salaries and depreciation.) The following information is provided about GGI’s current operations: Sales and production cost data for 20,000 bags, per bag: Sales price $ 40 Variable manufacturing costs 17 Variable selling costs 3 Fixed manufacturing costs 12 Fixed marketing costs 4 No marketing costs would be associated with the special order. Because the order would be used in research and consistency is critical, APAC requires that GGI fill the entire order of 5,000 bags. Required: 1. What is the total relevant cost of filling this special sales order? 2. What would be the change in operating income if the special order is accepted? 3. What is the break-even selling price per unit for the special sales order (i.e., what is the selling price that would result in a zero effect on operating income)? 4. Prepare comparative income statements, using the contribution format, for both the current situation and assuming the special order is accepted at the break-even price determined in requirement 3.

Answer 1

Part 1

Relevant cost = variable manufacturing cost + opportunity cost = ((5000*17)+2500)+((25000-22000)*(40+17+3)) = 267500

Part 2

Change in net operating income = change in revenue – change in cost = 130000-267500 = ($137500)

Part 3

Breakeven selling price = 267500/5000= $53.5

Part 4

	Current situation		Current situation + special order
Sales (40)	800000		680000 (17000*40)
Special order (53)		800000	267500 (5000*53.5)	947500
Less: variable costs:
Manufacturing (17)	340000		374000(22000*17)
Marketing (3)	60000	400000	51000 (17000*3)	425000
Contribution margin		400000		520000
Less fixed costs
Manufacturing	240000	240000	240000
One-time payment			2500	242500
		160000		277500