Question

Question 2 The LFC Company manufactures a variety of electric motors. The business is currently operating at 70% of capacity and is earning a satisfactory return on investment. Fenway International (FI) has approached the management of LFC with an offer to buy 120,000 units of an electric motor. Fl manufactures a motor that is almost identical to LFC's motor, but a fire at the Fl plant has shut down its manufacturing operations. Fl needs the 120,000 motors over the next four months to meet commitments to its regular customers and Fl is prepared to pay £19 each for the motors, which it will collect from the LFC plant. LFC's product cost, based on current planned cost for the electric motor, is: Direct materials 5.00 Direct labour (variable) 6.00 Manufacturing overheads 9.00 Total 20.00 Manufacturing overheads are applied to production at the rate of £18.00 a direct labour hour. This manufacturing overheads rate is made up of the following components: Variable factory overhead 6.00 Fixed factory overhead - direct 8.00 Fixed factory overhead - allocated 4.00 Applied manufacturing overhead rate 18.00 Additional costs usually incurred in connection with sales of electric motors include sales commissions of 5% and transportations costs of £1 per motor.

Answer 1

Answer is given below with all working

a) £2,280,000 (120,000*19) £600,000 £720,000 Evaluation of Special order Sales at Offer price Less: Variable cost Direct material Direct Labor Variable factory overhead Total variable cost Incremental contrition Fixed cost Incremental profit (120,000*5) (120,000*6) (120,000*3) £1,680,000 £600,000 £60,000 (15000*4) £540,000 Yes offer should be accepted since there is incremental profit b) Minimum Unit price Variable cost Incremental Fixed cost Total product cost Mark up at 40% Total Sales value Total units Minimum unit price £1,680,000 £60,000 £1,740,000 £696,000 £2,436,000 120,000 £20.30 c) Assumptions Existing Fixed overheads is irrelevant in evaluation of special order Only incremental overheads is relevant in evaluation of special order Relevant variable cost includes only direct material, direct labour and variable factory overhead No sales commission on special order No transportation cost since the customer is collecting the order from plant Other factors No loss of existing sales units No additional demand during next 4 months Cost to service orders remains same in next 4 months