Question

KidSport Ltd produces cricket bats for kids that it sells for $37 each. At capacity, the company can produce54 000 bats a year. The costs of producing and selling 54 000 bats are as follows:

KidSport Ltd produces cricket bats for kids that it sells for $37 each. At capacity, the company car produce54 000 bats a year. The costs of producing and selling 54 000 bats are as follows: Total costs Cost per bat $14 $756 000 Direct materials Direct production labour 216 000 Variable production overhead Fixed production overhead Variable selling expenses Fixed selling expenses 108 000 5 270 000 108 000 2 162 000 $1 620 000 Total costs 1. Suppose that KidSport is currently producing and selling 44 000 bats. At this level of production and sales, its fixed costs are the same as given in the preceding table. Homemade Ltd wants to place a one-time special order for 10 000 bats at $21 each. KidSport will incur no variable selling costs for this special order. Should KidSport accept this one-time special order? Show your calculations. 2. Now suppose that KidSport is currently producing and selling 54 000 bats. If(20 marks) KidSport accepts Homemade's offer, it will have to sell 10 000 fewer bats to its regular customers. a) On financial considerations alone, should KidSport accept this one-time special order? Show your calculations. b) On financial considerations alone, at what price would KidSport be indifferent between accepting the special order and continuing to sell to its regular customers at $37 per bat? c) What other factors should KidSport consider in deciding whether to accept the one-time special order? (20 marks) (20 marks) (10 marks) (30 marks)

Answer 1

Solution-1 Calculation of incremental cost for 10,000 units demanded by Homemade Ltd KidSport Itd will only incur variable costs on the additional 10,00 units as its fixed costs are already being incurred in totality for the production of existing 44,000 units Cost per bat Direct materials Direct production labour Variable production overhead Variable selling expenses Total variable cost $14 per bat $4 per bat $2 per bat NIL (given in question) $20 per bat Total cost (Calculated as cost per bat* 10,000) $140,000 $40,000 $20,000 So $200,000 Since, Homemade Ltd. is offering $21 per bat which is more than the incremental cost per bat for KidSport Ltd i.e. $20, this one-time order should be accepted and it will yield a contribution of $1 per unit [calculated as ($21-$20)] and $10,000 in total (calculated as 10,000*($21-$20)]

Solution-2 (a) Since fixed costs are going to be same in both alternatives, they are irrelevant for decision making. The alternative that offers higher contribution per unit must be chosen. Calculation of contribution per unit that KidSport will have to forego to accept one-time order Cost per bat Total cost (Calculated as cost per bat* 10,000) Direct materials $14 per bat $140,000 Direct production labour $4 per bat $40,000 Variable production overhead $2 per bat $20,000 Variable selling expenses $2 per bat $20,000 Total variable cost $22 per bat $220,000 Selling price to existing $37 per bat $370,000 customers Contribution per unit from $15 (i.e. $37-$22) $150,000 existing customer At present, existing customers are paying $37 pe unit wherein the incremental costs are $22 per unit, hence resulting in a contribution of $15 per unit (i.e. $37-$22) as compared to $1 per unit contribution opportunity from one-time special order. Therefore, KidSport Itd. should not accept one-time order and continue to sell 10,000 units to existing customers as it yields the company extra contribution of $14 per unit (i.e. $15-$1). Solution-2(b) Since, as calculated in part (b) above that kidsport ltd is making an additional contribution of $14 per unit from existing customers when compared to one-time special order, therefore if Homemade Itd increases their offer price for 10,000 units by $14 per unit, KidSport Itd will be indifferent between the two options. In that case, the price from Homemade Itd would be $35 per bat (calculated as $21+$14)

Solution-2 (0) Other factors that should be considered: Every business decision is taken not just from immediate perspective but from long-term perspective. The few factors that KidSport should consider while deciding whether to accept the one-time order are as follows: Assess the implications on future business due to this decision. On the one hand, if the company accepts the one-time order, it may turn off its existing regular customers. On the other hand, the company must assess the potential benefits of starting business relationship with Homemade Itd. and the benefits it can yield in the future growth of the business. The decision must be taken not just on the basis of financial comparability of existing offer but on the potential future growth potential from different customers and what they could bring to the table in future. If Kidsport Itd decides to turn away the existing customers for 10,000 bats, it should assess the potential impact on customer loyalty of other existing customers (i.e. customers for other 44,000 bats). The company wouldn't like to impact its customer relationships for one new client. KidSport Itd must also assess the impact of the above decision on its brand image & management's image in the market, not just with its customers as mentioned above, but also with its suppliers, investors, and other stakeholders. It must also assess its existing future expansion plans, goals and take a decision that makes most sense given the targeted objectives