Question

MSI has been approached by a fourth-grade teacher from Portland about the possibility of creating a specially designed game that would be customized for her classroom and environment. The teacher would like an educational game to correspond to her classroom coverage of the history of the Pacific Northwest, and the state of Oregon in particular. MSI has not sold its products directly to teachers or school systems in the past, but its Marketing Department identified that possibility during a recent meeting.

The teacher has offered to buy 2,300 copies of the CD at a price of $6.00 each. MSI could easily modify one of its existing educational programs about U.S. history to accommodate the request. The modifications would cost approximately $410. A summary of the information related to production of MSI’s current history program follows:

3-a. Calculate the incremental effect on profit if the POP product is eliminated. Suppose that $1,200 of the common fixed costs could be avoided if the POP product line were eliminated.

Direct materials

$

1.07

Direct labor

0.42

Variable manufacturing overhead

2.16

Fixed manufacturing overhead

1.80

Total cost per unit

$

5.45

Sales price per unit

$

13.00

Required:
1. Compute the incremental profit (or loss) from accepting the special order.

Profit (or Loss)

by

2. Should MSI accept the special order?

	Yes
	No

3. Suppose that the special order had been to purchase 2,300 copies of the program for $5.50 each. Compute the incremental profit (or loss) from accepting the special order under this scenario.

Profit (or Loss)

by

4. Suppose that MSI is operating at full capacity. To accept the special order, it would have to reduce production of the history program. Compute the special order price at which MSI would be indifferent between accepting or rejecting the special order. (Round your answer to 2 decimal places.)

	Special Order Price

MSI is considering outsourcing the production of the handheld control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 26,000 units of the module per year for $35.00 each. The following information pertains to MSI’s production of the control modules:        

Direct materials	$	20
Direct labor		10
Variable manufacturing overhead		4
Fixed manufacturing overhead		3
Total cost per unit	$	37

MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production.

Required:
1. Compute the difference in cost between making and buying the control module.

Difference in Cost

2. Should MSI buy the modules from MLC or continue to make them?

Buy

Make

3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $46,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

Difference in Cost

3-b. Does this change your recommendation to MSI?

	No
	Yes

MSI is considering eliminating a product from its ToddleTown Tours collection. This collection is aimed at children one to three years of age and includes “tours” of a hypothetical town. Two products, The Pet Store Parade and The Grocery Getaway, have impressive sales. However, sales for the third CD in the collection, The Post Office Polka, have lagged the others. Several other CDs are planned for this collection, but none is ready for production.

MSI’s information related to the ToddleTown Tours collection follows:

Segmented Income Statement for MSI’s
ToddleTown Tours Product Lines
	Pet Store Parade			Grocery Getaway			Post Office Polka				Total
Sales revenue	$	125,000		$	120,000		$	34,000			$	279,000
Variable costs		53,000			49,000			30,000				132,000
Contribution margin	$	72,000		$	71,000		$	4,000			$	147,000
Less: Direct Fixed costs		7,800			7,600			3,200				18,600
Segment margin	$	64,200		$	63,400		$	800			$	128,400
Less: Common fixed costs*		6,250			6,000			1,700				13,950
Net operating income (loss)	$	57,950		$	57,400		$	(900	)		$	114,450

      
*Allocated based on total sales dollars.

MSI has determined that elimination of the Post Office Polka (POP) program would not impact sales of the other two items. The remaining fixed overhead currently allocated to the POP product would be redistributed to the remaining two products.

Required:
1. Calculate the incremental effect on profit if the POP product is eliminated.

Effect on Profit

2. Should MSI drop the POP product?

	Yes
	No

3-a. Calculate the incremental effect on profit if the POP product is eliminated. Suppose that $1,200 of the common fixed costs could be avoided if the POP product line were eliminated.

Effect on Profit

3-b. Should MSI drop the POP product?

	Yes
	No

Answer 1

1. Incremental profit/loss from accepting the special order:

Increase in sales - increase in variable costs - modification costs

= (2300 units x $6) - (2300 units x {$1.07+$0.42+$2.16}) - $410

= 13800 - 8395 -410 = $4995

Profit increase by $4995

2. Yes, MSI should accept the additional order as it increases the profit as shown above

3. Special order to purchase 2300 copies @ $5.5 each

Incremental profit/loss from accepting the special order:

Increase in sales - increase in variable costs - modification costs

= (2300 units x $5.5) - (2300 units x {$1.07+$0.42+$2.16}) - $410

= 12650 - 8395 -410 = $3845

Profit increase by $3845

4. Special order price = incremental cost + contribution lost per unit

= (3.65+ 410/2300) + ( 13- 3.65)

= 3.83 + 9.35 = $13.18