Question

This is a special order problem that also requires that you use the high low method to estimate some cost function parameters, so you may want to review the high-low method lectures in Module 1. As with almost all of the analyses that we have done, determining variable and fixed costs, and knowing what to do with them, is critical. ______________________________________________________ Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 24,500 units of a power steering system component for $195 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.75 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market. Huang's production and cost information for the last two years for the component are as follows: 207,000 units 235,000 units Direct material costs $16,974,000 $19,270,000 Direct labor costs 4,657,500 5,287,500 Overhead costs 24,178,000 25,690,000 Selling and administrative costs 7,380,500 7,702,500 Total costs $53,190,000 $57,950,000 Total costs per unit $256.96 $246.60 T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $195 per unit offer is not only below the regular $250 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $220,000 and that Huang will have to lease some special equipment for $300,000. Required 1. Using the high-low method to determine cost behavior, what would the expected profit be on the special order (use a negative sign for a loss)?

Answer 1

Statement showing Incremental Income /Loss from from New order acceptance
Now, Expected sales units form new order	24500
Selling price per unit	$195.00
Revised Variable cost per unit ($170+ 2.75)	$172.75
Contribution earned per unit (195-172.75)	$22.25
Addtional contribution from order (24,500 units @22.25)	$5,45,125
Additional Fixed cost($ 300,000 + $ 220,000)	$5,20,000
Additional profit earned from order( 551250 -520000)	$25,125
Hence order should be accepted

Computation of Variable Cost per Unit & Fixed Cost

Variable cost per unit = Change in total cost / change in units

= (57,950,000-53,190,000)/(235,000-207,000) = $ 170 per unit

Total fixed cost = Total cost- variable cost = 57,950,000 - 235,000 units@170 = $ 18,000,000