Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 34,000 Rets per year. Costs associated with this level of production and sales are given below:

  

	Unit			Total
Direct materials	$	20		$	680,000
Direct labor		6			204,000
Variable manufacturing overhead		3			102,000
Fixed manufacturing overhead		5			170,000
Variable selling expense		2			68,000
Fixed selling expense		6			204,000
Total cost	$	42		$	1,428,000

   

The Rets normally sell for $47 each. Fixed manufacturing overhead is constant at $170,000 per year within the range of 28,000 through 34,000 Rets per year.

  

Required:
1.	Assume that due to a recession, Polaski Company expects to sell only 28,000 Rets through regular channels next year. A large retail chain has offered to purchase 6,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 6,000 units. This machine would cost $12,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. Determine the impact on profits next year if this special order is accepted.

      Net Profit Increases by

2.

Refer to the original data. Assume again that Polaski Company expects to sell only 28,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 6,000 Rets. The Army would pay a fixed fee of $1.40 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. If Polaski Company accepts the order, by how much will profits increase or decrease for the year?

      Net Profit Increases by

3.	Assume the same situation as that described in (2) above, except that the company expects to sell 34,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 6,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 6,000 Rets were sold through regular channels?

      Net Profit Decreases by

Answer 1

Option		Amount $
1	Net increase in profits by	166320
2	Net increase in profits by	38400
3	Net Decrease in profits	-57600

Working notes for the above answer is as under

1

Calculation of the impact on profits next year if this special order is accepted
Incremental Revenue = 6000*(47 * (1-16%))	355320
Less:
Direct Material Cost = 6000*20	-120000
Direct Labor Cost =6000*6	-36000
Variable Manufacturing Cost =6000*3	-18000
Variable Selling Expenses =6000*2*(1-75%)	-3000
Cost of Special Machine	-12000
Net increase in profits	166320

2

Calculation of the impact on profits next year if this special order is accepted
Incremental Revenue = 6000*1.4	8400
Additional recovery of   Fixed manufacturing overhead = 6000*5	30000
Net increase in profits	38400

3

Incremental Revenue = 6000*1.4	8400
Additional recovery of   Fixed manufacturing overhead = 6000*5	30000
Less: Loss on contribution on regular units =6000*(47-20-6-3-2)	-96000
Net Decrease in profits	-57600