Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 23,000 units of a power steering system component for $197 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $3.00 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:

	193,000 units	229,000 units
Direct material costs	$16,019,000	$19,007,000
Direct labor costs	5,211,000	6,183,000
Overhead costs	23,325,500	25,251,500
Selling and administrative costs	11,233,500	11,575,500
Total costs	$55,789,000	$62,017,000
Total costs per unit	$289.06	$270.82

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $197 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 $200,000 and that Huang will have to lease some special equipment for $295,000.

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	193,000	229,000
Direct material	16,019,000	19,007,000
Direct Labor	5,211,000	6,183,000
Overhead costs	23,325,500	25,251,500
Selling and Admin cost	11,233,500	11,575,500
Total cost	55,789,000	62,017,000
Using high low method, variable cost per unit = Difference in Cost/Difference in Volume
Overhead	53.5	per unit
Selling and Admin Cost	9.5	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	4,531,000
Less: costs
Direct material	1,909,000
Direct Labor	621,000
Overhead costs	1,230,500
Selling and Admin cost	218,500
Shipping cost	69,000
Setup costs	200,000
Lease cost	295,000
Total cost	4,543,000
Profit from special order	-12,000
Expected Profit = -$12000 i.e. loss