Question

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows.

Materials	$	27.00
Labor		18.00
Variable overhead		7.50
Fixed overhead ($405,000 per year; 45,000 units per year)		9.00
Total	$	61.50

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 3,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $63 per pack. The regular selling price is $90. The special order would require some modification to the basic model. These modifications would add $6.00 per unit in material cost, $2.50 per unit in labor cost, and $0.70 in variable overhead cost. Although Fairmount has the capacity to produce the 3,000 units without affecting its regular production of 45,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $7,500 and would allow Fairmount to test up to 5,000 units.

Required:

a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont’s profits for the year.

b. Do you agree with the decision to accept the special order?

c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable.

Answer 1

In 1000's

	STATUS QUO	48000UNITS	DIFFERENCE	HIgher/Lower
REVENUE	4050	4239[4050+3000*63]	189	H
LESS VARIABLE
MATERIAL	1215	1314[27*45000+33*3000]	99	H
LABOR	810	871.5[810+3000*20.5]	61.5	H
VARIABLE	337.5	362.1[337.5+8.2*3000]	24.6	H
TOTAL VARIABLE COST	2362.5	2547.6	185.1	H
CONTRIBUTION MARGIN	1687.5	1691.4	3.9	H
LESS FIXED COST	405	412.5[405+7.5RENT]	7.5	H
OPERATING PROFIT (LOSS)	1282.5	1278.9	3.6	LOWER

COST FOR 3000UBACKPACKS

MATERIAL = 27 +6 =33

LABOR = 18+2.5 = 20.5

OVERHEAD = 7.50+0.70=8.2

2.NO , do not agree with the decision to accept the special order.As it lowers the profit

3.MINIMUM QUANTITY = ADDITIONAL FIXED COST /CONTRIBUTION MARGIN PER UNIT

=7500/(63-33-20.5-8.2]

7500/1.3

=5770UNITS ARE REQUIRED