Question

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows. Materials Labor Variable overhead Fixed overhead ($3,379,900 per year; 463,000 units per year) Total $19.30 13.30 6.30 7.30 $ 46.20 Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 32,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $51 per pack. The regular selling price is $73. The special order would require some modification to the basic model. These modifications would add $5.30 per unit in material cost, $2.80 per unit in labor cost, and $1.80 in variable overhead cost. Although Fairmount has the capacity to produce the 32,000 units without affecting its regular production of 463,000 units, a one-time rental of special testing equipment to meet Riverside's requirements would be needed. The equipment rental would be $81,400 and would allow Fairmount to test up to 63,000 units. Required: a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont's profits for the year. b. Do you agree with the decision to accept the special order? c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable.

Answer 1

(a)

	(All costs in Thousands of Dollars)
	Status Quo 463000 units	Alterntive 495000 units	Difference
Sales Revenue	$33799	$35431	$1632	higher
Less variable costs:
Material	$8935.9	$9723.1	$787.2	higher
Labour	$6157.9	$6673.1	$515.2	higher
Variable overhead	$2916.9	$3176.1	$259.2	higher
Total Variable cost	$18010.7	$19572.3	$1561.6	higher
Contribution Margin	$15788.3	$15858.7	$70.4	higher
Less: Fixed Costs	$3379.9	$3461.3	$81.4	higher
Operating Profit/(Loss)	$12408.4	$12397.4	$-11	lower

Fixed cost for the alternative = (3379900+81400)/1000 = $3461.3 thousand

(b)

The Operating Profit is decreasing by $11000 , if special order is accepted. So the decision to accept the special order is not acceptable.

(c) Calculation of contribution p.u for special order:

Selling price p.u	$51.0
Less variable costs:
Material	$24.6
Labour	$16.1
Variable overhead	$8.1
Total Variable cost	$48.8
Contribution Margin	$2.2

Profit reduced in special order= $11000

Therfore, additional units in the special order to make it profitable = $11000/$2.2 = 5000 units.

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