Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 25,000 units of a power steering system component for $200 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.50 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market. To determine variable and fixed costs, Huang's accountant used the high-low method with the following production and cost information for the last two years: Direct material costs Direct labor costs Overhead costs Selling and administrative costs Total costs Total costs per unit 198,000 units $17,127,000 4,752,000 24,390,000 7,283,000 $53,552,000 $270.46 227,000 units $19,635,500 5,448,000 25,985,000 7,529,500 $58,598,000 $258.14 T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $200 per unit offer is not only below the regular $250 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $285,000 and that Huang will have to lease some special equipment for $260,000. REQUIRED [6 tries] 1. Using the high-low method to determine cost behavior, what would the expected profit be on the special order (use a negative sign for a loss)?

Answer 1

Units	198,000	227,000
Direct material	17,127,000	19,635,500
Direct Labor	4,752,000	5,448,000
Overhead costs	24,390,000	25,985,000
Selling and Admin cost	7,283,000	7,529,500
Total cost	53,552,000	58,598,000
Using high low method, variable cost per unit = Difference in Cost/Difference in Volume
Overhead	55.00	per unit
Selling and Admin Cost	8.50	per unit
Direct material and direct labor are variable costs
Since there is spare capacity, only incremental costs are relevant for the special order
Calculation of profit from special order:
Revenue	5,000,000
Less: costs
Direct material	2,162,500
Direct Labor	600,000
Overhead costs	1,375,000
Selling and Admin cost	212,500
Shipping cost	62,500
Setup costs	285,000
Lease cost	260,000
Total cost	4,957,500
Profit from special order	42,500
Should be accepted