Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 22,500 units of a power steering system component for $195 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.50 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.

To determine variable and fixed costs, Huang's accountant used the high-low method with the following production and cost information for the last two years:

	191,000 units	221,000 units
Total costs	$49,547,500	$54,722,500
Total costs per unit	$259.41	$247.61

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $195 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 $250,000 and that Huang will have to lease some special equipment for $265,000.

REQUIRED [6 tries]
1. Using the high-low method to budget costs of the special order, what would the expected profit on the special order be (use a negative sign for a loss)?

Answer 1

	Costs	Units
High level	54722500	221000
Low level	49547500	191000
Difference	5175000	30000
Variable production cost per unit	172.50	=5175000/30000
	Per unit	Total 22500
Incremental revenue	195.00	4387500
Incremental costs:
Variable production cost	172.50	3881250
Shipping cost	2.50	56250
Additional setup costs		250000
Lease cost		265000
Total Incremental costs		4452500
Incremental net operating income(loss)		-65000
Expected profit on the special order	-65000