Question

• The company produces and sells athletic shoes for children.
• The costs associated with each pair of shoes are estimated to be $14 of variable costs and $5 of fixed costs.
• The shoes normally sell for $35 per pair.
• A local children’s athletic league has offered to buy 100 pairs of shoes for $19 each.
• The company has excess capacity.

1. Which costs are irrelevant?
2. Which costs are relevant?
3. How much additional revenue would be earned if they accept the offer?
4. How much additional cost would be incurred if they accept the offer?
5. How much additional profit would be incurred if they accept the offer?
6. Should the company accept the offer?
7. What other factors should the company consider before accepting the offer?

Answer 1

1) Fixed costs are remains constant irrespective of level of output produced as fixed cost is not dependent on decision making.Hence Fixed cost is irrelevant for decision making as company has excess capacity.

2) Costs which are dependent for decision making or which would change as per the new decision, are considered to be relevant costs. Variable cost is relevant.

3)Additional Revenue= Additional Sale Output*Sales Price

=100*19

= $ 1900

4)Additional Cost= Additional Sale Output*Variable Cost

=100*14

=$ 1400

5) Addiitnal Profit = Additional Reveue - Additional Cost

=1900-1400

= $500

6)Yes, the company should accept offer for additional output as company is able to generate additional profit of $ 500.

7)The company should consider that sale of this additional output should not affect existing customers as company is selling this additional output at lower sales price.