Question

Sharman Athletic Gear Inc. (SAG) is considering a special order for 16,300 baseball caps with the logo of East Texas University (ETU) to be purchased by the ETU alumni association. The ETU alumni association is planning to use the caps as gifts and to sell some of the caps at alumni events in celebration of the university's recent national championship by its baseball team. Sharman's full manufacturing cost per hat is $4.30, which includes $2.15 fixed overhead cost related to plant capacity and equipment. ETU has made a firm offer of $42,000 for the hats, and Sharman, considering the price to be far below production costs, decides to decline the offer. Required: 1-a. Determine the total cost of the special order. Total cost of the special order 1-b. In terms of maximizing short-term operating profit, did Sharman make the wrong decision in declining the offer from ETU? Yes No

Answer 1

ANSWER:

(1a)

Incremental cost per unit = cost per unit - allocated fixed cost

= $4.30 - $2.15

= $2.15

therefore,

Total incremental cost = Number of units in order x Incremental cost per unit

= 16300 x $2.15

= $35045

Therefore, total cost of the special order is $35045

(1b)

As the price offered by ETU is more than the production cost, it has missed the opportunity of earning profit calculated as follows

i.e. $42000 - $35045

= $6955

Yes, Sharman has made a wrong decision of declining offer from ETU