Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 48,000 Rets per year. Costs associated with this level of production and sales are given below: Unit Total Direct materials $ 25 $ 1,200,000 Direct labor 10 480,000 Variable manufacturing overhead 3 144,000 Fixed manufacturing overhead 7 336,000 Variable selling expense 2 96,000 Fixed selling expense 6 288,000 Total cost $ 53 $ 2,544,000 The Rets normally sell for $58 each. Fixed manufacturing overhead is constant at $336,000 per year within the range of 39,000 through 48,000 Rets per year.

Required: 1. Assume that due to a recession, Polaski Company expects to sell only 39,000 Rets through regular channels next year. A large retail chain has offered to purchase 9,000 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 9,000 units. This machine would cost $18,000. 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? By?

2. Refer to the original data. Assume again that Polaski Company expects to sell only 39,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 9,000 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? By?

3. Assume the same situation as that described in (2) above, except that the company expects to sell 48,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 9,000 Rets. If the Army’s order is accepted, by how much will profits increase or decrease from what they would be if the 9,000 Rets were sold through regular channels?

net Profit? By?

Answer 1

1. Incremental profit due to the special order

Selling price per unit = 58*(1-0.16) = 48.72

Cost price per unit = direct material + direct labour + variable manufacturing overhead + variable selling expense*(1-0.75)

= 25+10+3+2*(1-0.75) = 38.5

So, incremental profit = 9000*(48.72-38.5) - 18000

= 73980

2. Incremental profit = 1.4 + fixed cost reimbursement since fixed cost will be occurring irrespective of order being accepted or not.

= 9000*(1.4+7)

= 75600

3. If 9000 would have been sold through regular channel, the profit would have been = 9000*(58-25+10+3+2) = 162000

So, accepting the order would result in loss of = 162000-75600

= 86400