Question

QUESTION 5 In downtown Clutchmore lies a famous French restaurant by the name of Parisian Restaurant Ltd. The establishment is owned and managed by Chef Albert. One of the signature products of the restaurant is its gourmet cakes, which is specially made in the restaurant's kitchen. The restaurant can make a maximum of 12,000 cakes per year. The company, however, is currently operating at 95% capacity. Each cake sells for $100. The variable costs based on the current 95% capacity are as follows: Direct materials Direct labour Variable overhead $ 456,000 $ 57,000 $ 171,000 $ 684,000 The fixed costs per year consist of the following: Fixed overhead Administration $ 130,000 $ 510,000 $ 640,000 Consider the following independent scenarios: Scenario A Grand Emporium Ltd has approached Parisian Restaurant Ltd to purchase 2,000 cakes for its promotional activities. As this is an unusually large order, Grand Emporium Ltd is only willing to pay a discounted total price of $180,000. They have also requested for the cakes to be packaged in specially made gift boxes which include the logos of both companies. This will incur an additional $3 variable cost per cake. The cheapest packing machine that can package the cakes to meet the requirement of Grand Emporium Ltd costs $12,000. Apart from the special order, there is no further use of this machine Scenario B Assembly Square Bakery has approached Parisian Restaurant Ltd to produce all cakes currently produced for the entire year for $102 per cake. As the buy option includes all necessary marketing and administration, Parisian Restaurant Ltd can reduce $500,000 of its fixed costs. Required: a) For Scenario A: (i) Calculate the incremental benefit (or cost) of the special order. (3% marks) (ii) Should Parisian Restaurant Ltd accept the special order? Discuss quantitative and qualitative factors. (Maximum 80 words) (3% marks) b) For Scenario B: (i) Prepare a table to compare the costs of the make and buy options. (2% marks) (ii) Should Parisian Restaurant Ltd continue making the cakes or buy them from Assembly Square Bakery? Discuss quantitative and qualitative factors. (Maximum 80 words) (3% marks)

Answer 1

Scenario 1:

Calculation of Excess Capacity
Particulars	Percentage	Quantity
Total Capacity	100%	12000
Currently Operating at	95%	11400
Idle Capacity	5%	600

Contribution per cake from normal Order
Particulars	Total Cost for 11400 Cakes	Cost per Cake
Direct Materials	456000	40
Direct Labour	57000	5
Variable overhead	171000	15
Variable Cost per Cake (B)	60
Selling Price (A)	100
Contribution per cake from normal Order (A-B)	40

Computation of Contribution per cake from new order
Particulars	Cost per Cake
Direct Materials	40
Direct Labour	5
Variable overhead	15
Additional Variable selling cost for this order	3
Total Variable Cost	63
Selling Price per Cake	90
Contribution per Cake	27

Particulars	Computation	Amount
Gain from making new order	Additional capacity of 600 units sold @ contribution of 27per unit	16200
Opportunity Loss from 1400 cakes	For 1400 cakes, the original contribution of $40 per cake dropped to $27 per cake.	18200
Additional Fixed Cost	Packing Machine	12000
Net Loss from new order	-14000

Another Method of solving

Loss before taking new order
Particulars	Amount
Direct Materials	456000
Direct Labour	57000
Variable overhead	171000
Total Variable Cost	684000
Add: Fixed Cost
Fixed Overhead	130000
Administration	510000
Total Fixed Cost	640000
Total Cost	1324000
Sales	1140000
Profit/(Loss)	-184000

Loss after taking new order
Particulars	For 10000 cakes	For 2000 extra orders
Sales	1000000	180000
Direct Materials	400000	80000
Direct Labour	50000	10000
Variable overhead	150000	30000
Additional variable cost for extra order	-	6000
Total Variable Cost	600000	126000
Contribution	400000	54000
Total Contribution	454000
Less: Fixed Cost
Fixed Overhead	130000
Administration	510000
Additional Fixed cost to be incurred for this order	12000
Total Fixed Cost	652000
Profit/(Loss)	-198000

Loss increased from 184000$ to $198000 that is Loss has been increased to the extent of 14000$. Based on the quantitative facators, we should not take the order as the loss is increasing. But based on some equalitative factors say if we are expanding our operating capacity in future so that emporium will become our new client, in such case we have to accept the order as in future if we expand we can satisfy the emporium demand also.

Scenario 2:

Loss if we make the cake
Particulars	Amount
Direct Materials	456000
Direct Labour	57000
Variable overhead	171000
Total Variable Cost	684000
Add: Fixed Cost
Fixed Overhead	130000
Administration	510000
Total Fixed Cost	640000
Total Cost	1324000
Sales	1140000
Profit/(Loss)	-184000

Loss if we buy the cake from square bakery
Particulars	Computation	Amount
Sales	$100*11400	1140000
Purchse from Assembly	102$*11400	1162800
Fixed Cost	640000-500000	140000
Profit/(Loss)		-162800

Based on the above quntitative factors, we can decide to buy the cake from Square bakery since the overall loss reduced by 21200$. But we also have to see some qualitative factors such as, the qulality of the raw materials used by Square bakery for preparing the cake, the taste diferrences if any between the cake prepared by us with the one prepared by square bakery.