Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 25,000 units of a power steering system component for $195 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:

198,000 units 234,000 units

Direct material costs $17,226,000 $20,358,000

Direct labor costs 4,752,000 5,616,000

Overhead costs 22,791,000 24,753,000

Selling and administrative costs 7,376,000 7,808,000

Total costs $52,145,000 $58,535,000

Total costs per unit $263.36 $250.15

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $195 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 $245,000 and that Huang will have to lease some special equipment for $235,000.

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

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Huang Automotive

High Low method

Variable cost=

(Highest activity cost- Lowest activity cost)/ (Highest activity units- Lowest activity units)

Material costs

Units

Labor Cost

Units

Overhead costs

Units

Selling and administrative costs

Units

Highest activity

20,358,000.00

234,000.00

Highest activity

5,616,000.00

234,000.00

Highest activity

24,753,000.00

234,000.00

Highest activity

7,808,000.00

234,000.00

Lowest activity

17,226,000.00

198,000.00

Lowest activity

4,752,000.00

198,000.00

Lowest activity

22,791,000.00

198,000.00

Lowest activity

7,376,000.00

198,000.00

Difference

3,132,000.00

36,000.00

Difference

864,000.00

36,000.00

Difference

1,962,000.00

36,000.00

Difference

432,000.00

36,000.00

Variable material cost per unit

87.00

Variable cost per unit

24.00

Variable cost per unit

54.50

Variable cost per unit

12.00

Fixed cost

Highest activity cost- (Highest units * Variable cost per unit)

Fixed cost

Highest activity cost- (Highest units * Variable cost per unit)

Fixed cost

Highest activity cost- (Highest units * Variable cost per unit)

Fixed cost

Highest activity cost- (Highest units * Variable cost per unit)

Fixed cost

20358000-(234000*87)

Fixed cost

5616000-(234000*24)

Fixed cost

24753000-(234000*54.5)

Fixed cost

7808000-(234000*12)

Fixed cost

-

Fixed cost

-

Fixed cost

12,000,000.00

Fixed cost

5,000,000.00

So,

So,

So,

So,

Variable material cost per unit is $ 87.

Variable labor cost per unit is $ 24.

Variable overhead cost per unit is $ 54.50.

Variable cost per unit is $ 12.

Fixed cost is $ 0.

Fixed cost is $ 0.

Fixed cost is $ 12,000,000.

Fixed cost is $ 5,000,000.

	Fixed Portion	Variable Portion
Direct material costs	-	87.00
Direct labor costs	-	24.00
Overhead costs	12,000,000.00	54.50
Selling and administrative costs	5,000,000.00	12.00
Total cost	17,000,000.00	177.50

Huang Automotive is operating at 75% capacity only. It means it has spare capacity of 25%. So it should accept export only if it is able to cover the variable cost at least and any other additional cost relevant to export.
		Special offer
Sell Price		195.00
Current Variable cost		177.50
Additional shipping cost		2.25
Total Variable cost		179.75
Contribution per unit		15.25
Number of units		25,000.00
Total Contribution		381,250.00
Additional setup costs		245,000.00
Lease of special equipment		235,000.00
Net Profit/(loss)		(98,750.00)
Huang Automotive will lose $ 98,750 if it exports. So it should not export.