Question

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Test II- Problem 1. Southland Tires has been approached by a large chain store that offers to buy 80,000 tires at P34. Delivery must be made within 30 days. Southland can produce 320,000 tires per month. Expected sales at regular prices for the coming month are 300,000 tires. Southland's sales manager believes that about 60% of sales lost during the month would be made up in later months. Price and cost data are as follows: -P 50 Selling Price Variable Costs: Production P 24 Selling Contribution Margin 30 6 P 20 Variable selling costs on the special order are only P 4 per unit Required: 1. Determine whether the company should accept the special order. 2. Determine the lowest price Southland could charge on the special order and not reduce its income. 3. Suppose now that the chain offers to buy 60,000 tires per month at P 34. The offer is for an entire year. Expected sales are 300,000 tires per month without considering the special order. Assume that any sales lost during the year would be permanent and not be made up in the following year. Determine whether the order should be accepted and determine the lowest price that Southland could accept. Return to your answer to requirement #1. Suppose that total monthly fixed costs are P4,800,000. Would you accept the special order? 4.

Answer 1

1. If the company takes the order, it will have to reduce normal sales by 60,000 as it has excess capacity of 20,000

Gross profit that the company will make on the order = 80,000 * 16 (selling cost of P4) = 1,280,000

Loss in profit due to taking the special order = 40% of (60,000 * 20) = 480,000

Therefore, the company should take the order as it would increase profits by 800,000 (1,280,000 - 480,000)

2. The lowest price would be the one in which the income generated from the special order offsets the loss in sales of 1,200,000 (60,000 * 20). Lowest price = 1,200,000 / 80,000 = 15

3. Expected monthly sales = 300,000

Excess capacity = 20,000

Per month loss in sales = 40,000 (60,000 - 20,000)

The contribution margin for units sold via special order = 50 - 30 - 4 = 16

The contribution margin for units sold via normal channels = 50 - 30 = 20

Therefore, if the order is accepted for the whole year, there would be a reduction in profit of 160,000 per month. Hence, the order shouldn't be accepted.

4. The order would still be accepted as the fixed cost would have to incurred irrespective of the acceptance or rejection of offer.