Question

Sherene Nili manages a company that produces wedding gowns. She produces both a custom product that is made to order and a standard product that is sold in bridal salons. Her accountant prepared the following forecasted income statement for March, which is a busy month:

	Custom Dresses			Standard Dresses			Total
Number of dresses		10			20			30
Sales revenue	$	48,500		$	28,500		$	77,000
Materials	$	9,700		$	7,700		$	17,400
Labor		19,700			8,700			28,400
Machine depreciation		570			270			840
Rent		3,900			2,500			6,400
Heat and light		1,100			700			1,800
Other production costs								2,500
Marketing and administration								7,400
Total costs							$	64,740
Operating profit							$	12,260

Ms. Nili already has orders for the 10 custom dresses reflected in the March forecasted income statement. The depreciation charges are for machines used in the respective product lines. Machines depreciate at the rate of $1 per hour based on hours used, so these are variable costs. In March, cutting and sewing machines are expected to operate for 840 hours, of which 570 hours will be used to make custom dresses. The rent is for the building space, which has been leased for several years at $6,400 per month. The rent, heat, and light are allocated to the product lines based on the amount of floor space occupied.

A valued customer, who is a wedding consultant, has asked Ms. Nili for a special favor. This customer has a client who wants to get married in early April. Ms. Nili's company is working at capacity and would have to give up some other business to make this dress. She can't renege on custom orders already agreed to, but she can reduce the number of standard dresses produced in March to 10. Ms. Nili would lose permanently the opportunity to make up the lost production of standard dresses because she has no unused capacity for the foreseeable future. The customer is willing to pay $23,500 for the special order. Materials and labor for the order will cost $5,700 and $9,700, respectively. The special order would require 125 hours of machine time. Ms. Nili's company would save 135 hours of machine time from the standard dress business given up. Rent, heat and light, and other production costs would not be affected by the special order.

Required:

a-1. Calculate the differential operating profit (loss). (Select option "increase" or "decrease", keeping Without special order as the base. Select "none" if there is no effect.)

b. What is the minimum price Ms. Nili should accept to take the special order?

Answer 1

computation of Operating Profit With Special Order
	Custom Dresses	Standard Dresses	Special Order	Total
No.	10	10	1	21
Sales Price	$4,850	$1,425
Sales Revenue	$48,500	$14,250	$23,500	$86,250
Material	$9,700	$3,850	$5,700	$19,250
Labor	$19,700	$4,350	$9,700	$33,750
Machine Depriciation	$570	$270	$125	$965
Rent	$3,900	$2,500		$6,400
Heat & Light	$1,100	$700		$1,800
Other production costs
Marktitng & Administration
Total Cost				$62,165
Operating Profit				$24,085

Statement showing Gain
	Without Special Order	With Special Order	Impact
Sales Revenue	$77,000	$86,250	$9,250
Less: Variable Cost
Material	$17,400	$19,250	$1,850
Labor	$28,400	$33,750	$5,350
Machine Depriciation	$840	$965	$125
Contribution Margin	$30,360	$32,285	$1,925
Less: Fixed Cost
Rent	$6,400	$6,400	$           -
Heat & Light	$1,800	$1,800	$           -
Other production costs	$2,500	$2,500	$           -
Marktitng & Administration	$7,400	$7,400	$           -
Operating Profit	$12,260	$14,185	$1,925
*Marketing & Admin cost has been treated as fixed cost.

b. Minimum Price would be equal to price as it can profit equal in case of withoput special order.

Special order price=$23500

-Increased profit=$(1925)

=$21575