Question

The Delmar Beverage Co. produces a premium root beer that is sold throughout its chain of restaurants in the Midwest. The company is currently producing 1,900 gallons of root beer per day, which represents 80% of its manufacturing capacity. The root beer is available to restaurant customers by the mug, in bottles, or packaged in six-packs to take home. The selling price of a gallon of root beer averages $13, and cost accounting records indicate the following manufacturing costs per gallon of root beer: Raw materials Direct labor Variable overhead Fixed overhead Total absorption cost $3.06 2.17 2.11 2.03 $9.37 In addition to the manufacturing costs just described, Delmar Beverage incurs an average cost of $1.05 per gallon to distribute the root beer to its restaurants. SaveMore Inc., a chain of grocery stores, is interested in selling the premium root beer in gallon jugs throughout its stores in the St. Louis area during holiday periods and has offered to purchase root beer from Delmar Beverage at a price of $10.00 per gallon. SaveMore believes it could sell 475 gallons per day. If Delmar Beverage agrees to sell root beer to SaveMore, it estimates the average distribution cost will be $1.52 per gallon.

Answer 1

Solution a:

	Per gallon
Raw Materials	$3.06
Direct Labor	$2.17
Variable Overhead	$2.11
Distribution	$1.52
Total relevant costs per gallon	$8.86

Solution b:

Computation of Increase in Operating income from special Order
Special order Price	$10.00
Less:Relevant cost per gallon	$8.86
Contribution Margin per gallon	$1.14
Number of gallons in special order	475
Increase in operating Income	$541.50

Solution c-1:

	Per gallon
Current Sales		$13.00
Less: Variable cost
Raw Materials	$3.06
Direct Labor	$2.17
Variable Overhead	$2.11
Distribution	$1.05
		$8.39
Current Contribution Margin		$4.61

Total Relevant Cost = $8.86 + $4.61 = $13.47

Solution c-2:

Decrease in Operating income = 475 * (Special Order price - Total relevant cost)

= 475 *($10 - $13.47) = $1648.25