Question

Please explain reasoning

1. Hunter Industries, Inc. is a manufacturer of soup and condiment products under its own standard and premium labels. The company has been in business for many years and is a "household name”. Their Denver soup plant has a capacity of 120,000 cases/mo, but has been operating at a normal volume of 95,000 cases/mo. Hunter has been approached by Dino Mart, a large discount retailer, about producing a line of soups under a Dino Mart house label. Dino would initially place an order for 16,000 cases/mo, with the understanding that the order will be expanded if the product is successful. The initial order would be for a reduced line of six relatively simple soups. The soups would be made following Hunter's recipes, except that some cheaper ingredients would be used, reducing cost by $1.50/case. All of these soups have essentially the same production cost of $26 per case, as follows: ingredients and packaging, $14; direct labor, $2; overhead, $10. The overhead is 65% fixed manufacturing costs, 10% variable manufacturing costs, and 25% allocated general corporate overhead. Hunter would incur $5,000/mo additional setup costs if the order is accepted. Packaging would cost ten cents/case less because of a cheaper label used by Dino. Hunter normally sells these soups for $34/case. Dino Mart has offered S20/case, arguing that the steep discount is necessary for them to price the product in conformity with their pricing philosophy and customer expectations. The regional marketing director is inclined to reject the offer, because it is below cost, and therefore Hunter will lose money on the contract. The ultimate decision is up to the regional director of operations. Required: Discuss the factors that the operations director should consider in making the decision.

Answer 1

In the given scenario Hunter industries Has a capacity of 120000 cases /mo and right now running at 95000 cases/mo

which means it has idle capacity of 25000 cases /mo

Dino mart want 16000 cases/mo , as we have idle capacity of 25000 cases / mo ,the order can be accepted from the point of view of idle capacity as hunter industries doesn't have to forgo any profit from its current situation .

The current production cost = $ 26

Variable expenses :	($)
Ingredient and packaging	14
Direct labor	2
Variable overhead = 10% of overhead (i.e $10)	1
Total variable expenses	17
Fixed cost = 65% of overhead (i.e 10)	6.5
General administrative overhead 25% of 10	2.5

If We accept the project the company will have lower  variable expense as compare to current expenses

There will reduction of $1.5 in ingredient cost and .10 cent in packaging cost

so new variable cost for the product will be = 17-1.5-.10

= $15.4

Dino mart is offering us $20 , so if we accept the order

The profitability income which we have

Sale price	$20
less variable cost	-$15.4
Contribution margin	$4.6
Qty required	$16000
total contribution margin (16000*4.6)	$73600
Less setup cost	-$5000
less general administrative overhead (16000*2.5	$40000
Profit margin	$28600

from the above table we see if order is accepted by Hunger industries it will be earning profit of $ 28600, because fixed cost of manufacturing product will remain same for hunger industries whether they accept the order or reject , the company will have same fixed cost till the capacity of 120000/case

and after accepting the order company will be using 111000 case/ mo capacity ,

so while considering the order will be take all the relevant cost in consideration and after considering it we are having profit margin of $28600

If we consider only operation cost of product then we will be not be considering the general administrative cost also which is 2.5 case/mo

so then profit we will be earning = 28600+ (16000*2.5)

= 28600+40000

= $ 68600

so all the factors of considering the project are showing positive result and hunger industries can accept the order