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	$	18.90
Labor		12.90
Variable overhead		5.90
Fixed overhead ($3,167,100 per year; 459,000 units per year)		6.90
Total	$	44.60

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 28,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $49 per pack. The regular selling price is $69. The special order would require some modification to the basic model. These modifications would add $4.90 per unit in material cost, $2.40 per unit in labor cost, and $1.40 in variable overhead cost. Although Fairmount has the capacity to produce the 28,000 units without affecting its regular production of 459,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $85,800 and would allow Fairmount to test up to 59,000 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.

(Note if you could do the math step by step that would be great, I always get so lost when I reach the Contribution margin)

Answer 1

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Fairmount Travel Gear
Ans a	A	B	C=A+B	Note
Particulars	Current cost	Cost increase by	Revised cost
Materials	18.90	4.90	23.80
Labor	12.90	2.40	15.30
Variable Overhead	5.90	1.40	7.30
Total cost per unit			46.40	D
Number of bags			28,000.00	E
Total variable cost			1,299,200.00	F=D*E
Equipment rental			85,800.00	G
Total cost			1,385,000.00	H=F+G
Sell price		49.00		I
Sale Value			1,372,000.00	J=I*E
Net Loss			13,000.00	K=H-I

Fixed costs are sunk costs and not relevant for this offer so not considered.

Workings
Total cost of 459,000 units.	Per Unit	Amount
Units	459,000.00
Sales revenue	69.00	31,671,000.00	This is 459,000 units $ sell price per unit i.e. $ 69.
Materials	18.90	8,675,100.00	This is 459,000 units $ Materials cost per unit i.e. $ 18.90.
Labor	12.90	5,921,100.00	This is 459,000 units $ Labor cost per unit i.e. $ 12.90.
Variable Overhead	5.90	2,708,100.00	This is 459,000 units $ Variable Overhead cost per unit i.e. $ 5.90.

Total cost of additional 22,000 units.	Per Unit	Amount
Units	28,000.00
Sales revenue	49.00	1,372,000.00	This is 28,000 units $ sell price per unit i.e. $ 49.
Materials	23.80	666,400.00	This is 28,000 units $ Materials cost per unit i.e. $ 23.80.
Labor	15.30	428,400.00	This is 28,000 units $ Labor cost per unit i.e. $ 15.30.
Variable Overhead	7.30	204,400.00	This is 28,000 units $ Variable Overhead cost per unit i.e. $ 7.30.
Total cost of 487,000 units.	Amount
Units	487,000.00		This is sum of 459,000 units and 28,000 units.
Sales revenue	33,043,000.00		This is sum of sales revenue of 459,000 units and 28,000 units.
Materials	9,341,500.00		This is sum of Materials cost of 459,000 units and 28,000 units.
Labor	6,349,500.00		This is sum of Labor cost of 459,000 units and 28,000 units.
Variable Overhead	2,912,500.00		This is sum of Variable Overhead cost of 459,000 units and 28,000 units.

Income Statement	459,000 units	487,000 units	Difference
Sales revenue	31,671,000.00	33,043,000.00	1,372,000.00	See Workings above
Less: Variable costs
Materials	8,675,100.00	9,341,500.00	666,400.00	See Workings above
Labor	5,921,100.00	6,349,500.00	428,400.00	See Workings above
Variable Overhead	2,708,100.00	2,912,500.00	204,400.00	See Workings above
Total Variable costs	17,304,300.00	18,603,500.00	1,299,200.00	See Workings above
Contribution	14,366,700.00	14,439,500.00	72,800.00	See Workings above
Less: Fixed costs
Fixed Overhead	2,853,900.00	2,853,900.00	-	This is already given in the question.
Equipment rental		85,800.00	85,800.00	This is already given in the question.
Total Fixed costs	2,853,900.00	2,939,700.00	85,800.00
Net profit	11,512,800.00	11,499,800.00	(13,000.00)

Ans b

Fairmount Travel Gear will lose $13,000 if it accepts the offer. So the offer should not be accepted.

Ans c	Amount $
Total cost	1,385,000.00
Sell Price	49.00
Number of units	28,265.31

So minimum quantity should be 28,265 bags to attain breakeven point. Any quantity above 28,265 bags will give profits.