Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 38,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	760,000
Direct labor		10				380,000
Variable manufacturing overhead		3				114,000
Fixed manufacturing overhead		7				266,000
Variable selling expense		4				152,000
Fixed selling expense		6				228,000
Total cost	$	50			$	1,900,000

The Rets normally sell for $55 each. Fixed manufacturing overhead is $266,000 per year within the range of 29,000 through 38,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 29,000 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. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 29,000 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. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 38,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 9,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

Answer 1

1	Financial advantage (disadvantage)	$       91,800
2	Financial advantage (disadvantage)	$ 75,600
3	Financial advantage (disadvantage)	$     -86,400

Working:

1.

Sales [9000 x ($55 x 84%)]		415800
Less: Expenses
Direct materials (9000 x $20)	180000
Direct labor (9000 x $10)	90000
Variable manufacturing overhead (9000 x $3)	27000
Variable selling expense [9000 x ($4 x 25%)]	9000
Cost of special machine	18000
Total expenses		324000
Financial advantage (disadvantage) $		91800

2.

Revenue
Fixed fee (9000 x $1.40)		12600
Reimbursement of costs
Direct materials (9000 x $20)	180000
Direct labor (9000 x $10)	90000
Variable manufacturing overhead (9000 x $3)	27000
Fixed manufacturing overhead (9000 x $7)	63000	360000
Total revenue		372600
Less: Expenses
Direct materials (9000 x $20)	180000
Direct labor (9000 x $10)	90000
Variable manufacturing overhead (9000 x $3)	27000
Total expenses		297000
Financial advantage (disadvantage) $		75600

Note: Fixed manufacturing overhead will remain unchanged even if the one-time-only purchase order from the U.S. Army is accepted since the production is within the relevant range. Hence, the same is not considered under the expenses however, since all variable and fixed costs of production will be reimbursed, the same is considered in the total revenue.

3.

Revenue from U.S. Army	372600
Revenue from regular customers (9000 x $55)	495000
Net increase (decrease) in revenue	-122400
Add: Savings in variable selling expenses (9000 x $4)	36000
Financial advantage (disadvantage) $	-86400