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.
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Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 23,000 units of a power steering system component for $200 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.00 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:

	191,000 units	226,000 units
Direct material costs	$15,948,500	$18,871,000
Direct labor costs	5,539,000	6,554,000
Overhead costs	22,909,500	24,817,000
Selling and administrative costs	11,196,500	11,599,000
Total costs	$55,593,500	$61,841,000
Total costs per unit	$291.07	$273.63

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $200 per unit offer is not only below the regular $270 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $210,000 and that Huang will have to lease some special equipment for $265,000.

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

Total cost of 191,000 units= $55,593,500 Total cost of 226,000 units = $61,841,000 Therefore, Variable cost per unit = Change in total cost / change in units

=(61,841,000-55,593,500)/(226,000-191,000)=$178.5

Fixed cost=Highest Activity Cost - (Variable Cost Per Units x Highest Activity Units)

=61,841,000-(178.5*226000)=$21,500,000

Calculation of expected profit on special order:

Particulars	Amount(in $)
Variable cost of 23,000units@$178.5 each	4,105,500
Add: set up Cost	210,000
special equipment cost	265,000
Shipping charges @$2 each	46,000
Total cost	4,626,500
Total cost per unit(A)	201.15
Selling Price (B)	200.00
Loss	-1.15

Fixed Cost is considered because it is unavaoidable cost, Huang Automotive is already doing production at its capacity and fixed cost would have been incurred otherwise.