Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 26,000 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 $2.25 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:

	192,000 units	230,000 units
Direct material costs	$16,704,000	$20,010,000
Direct labor costs	5,760,000	6,900,000
Overhead costs	24,752,000	26,880,000
Selling and administrative costs	12,304,000	12,760,000
Total costs	$59,520,000	$66,550,000
Total costs per unit	$310.00	$289.35

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 $270 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $260,000 and that Huang will have to lease some special equipment for $200,000.

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	192,000	230,000
Direct material	16,704,000	20,010,000
Direct Labor	5,760,000	6,900,000
Overhead costs	24,752,000	26,880,000
Selling and Admin cost	12,304,000	12,760,000
Total cost	59,520,000	66,550,000
Using high low method, variable cost per unit = Difference in Cost/Difference in Volume
Overhead	56	per unit
Selling and Admin Cost	12	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	5,200,000
Less: costs
Direct material	2,262,000
Direct Labor	780,000
Overhead costs	1,456,000
Selling and Admin cost	312,000
Shipping cost	58,500
Setup costs	260,000
Lease cost	200,000
Total cost	5,328,500
Profit from special order	-128,500

в 1 2 Units 192000 230000 3 Direct material 16704000 =B3*C2/B2 4 Direct Labor 5760000 =B4*C2/B2 5 Overhead costs 24752000 26880000 6 Selling and Admin cost 12304000 12760000 7 Total cost =SUM(B3:36) =SUM(C3:06) 8 9 Using high low method, variable cost per unit = Difference in Cost/Difference in Volume 10 Overhead =(C5-B5)/(C2-B2) per unit 11 Selling and Admin Cost =(C6-B6)/(C2-B2) per unit 12 13 Direct material and direct labor are variable costs 14 Since there is spare capacity, only incremental costs are relevant for the special order Iner 15 = 26000*200 16 Calculation of profit from special order: 17 Revenue 18 Less: costs 19 Direct material 20 Direct Labor 21 Overhead costs 22 Selling and Admin cost 23 Shipping cost 24 Setup costs 25 Lease cost 26 Total cost 27 Profit from special order 28 20 =26000*B3/B2 =26000*B4/B2 =26000*B10 =26000*B11 =26000*2.25 260000 200000 =SUM(B19:B25) =B17-B26