Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company...

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 38,000 Rets per year. Costs associated with this level of production and sales are given below:

Unit Total Direct materials $ 25 $ 950,000 Direct labor 8 304,000 Variable manufacturing overhead 3 114,000 Fixed manufacturing overhead 5 190,000 Variable selling expense 4 152,000 Fixed selling expense 6 228,000 Total cost $ 51 $ 1,938,000

The Rets normally sell for $56 each. Fixed manufacturing overhead is $190,000 per year within the range of 31,000 through 38,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 31,000 Rets through regular channels next year. A large retail chain has offered to purchase 7,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 7,000 units. This machine would cost $14,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 31,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 7,000 Rets. The Army would pay a fixed fee of $1.40 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 38,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 7,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

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Answer #1

1.

Sales [7000 x ($56 x {1 - 0.16})] 329280
Less: Expenses
Direct materials (7000 x $25) 175000
Direct labor (7000 x $8) 56000
Variable manufacturing overhead (7000 x $3) 21000
Variable selling expense [7000 x ($4 x {1 - 0.75})] 7000
Cost of special machine 14000
Total expenses 273000
Financial advantage $ 56280

Note: The fixed manufacturing overhead will be incurred irrespective of whether the special order is accepted or not and hence is irrelevant.

2.

Revenue:
Fixed fee (7000 x $1.40) 9800
Reimbursement of costs
Direct materials (7000 x $25) 175000
Direct labor (7000 x $8) 56000
Variable manufacturing overhead (7000 x $3) 21000
Fixed manufacturing overhead (7000 x $5) 35000 287000
Total revenue 296800
Less: Expenses
Direct materials (7000 x $25) 175000
Direct labor (7000 x $8) 56000
Variable manufacturing overhead (7000 x $3) 21000
Total expenses 252000
Financial advantage $ 44800

Note: Fixed manufacturing overhead will remain unchanged even if the one-time-only purchase order from the U.S. Army is accepted since the production is within the relevant range. Hence, the same is not considered under the expenses however, since all variable and fixed costs of production will be reimbursed, the same is considered in the total revenue.

3.

Revenue from the U.S. Army 296800
Revenue from regular customers (7000 x $56) 392000
Net increase (decrease) in revenue -95200
Add: Savings in variable selling expenses (7000 x $4) 28000
Financial (disadvantage) $ -67200
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