Question

Lucca Ladies Shoes, an exclusive Italian shoe manufacturer, sells their handcrafted women’s fashion originals for about $300 per pair. Suppose the company incurs the following average costs per pair of shoes:

                                                Direct Materials                                $80

                                                Direct Labor                                      28

                                                Variable Manufacturing Overhead       22

                                                Variable Marketing Expenses                4

                                                Fixed Manufacturing Overhead       32*

                                                            Total Costs (per pair)          $166

           

                                                      *    $4,000,000 Total Fixed Mfg. O/H

                                                                  125,000 Pairs of Shoes

Lucca has enough idle capacity to accept a one-time only custom special order from a specialty department store in Miami and the South Florida area for 20,000 pairs of a special design ladies summer shoe at $142 per pair. Lucca will not incur any additional variable marketing expenses for the special order.

a. How would this special order affect Lucca’s operating income?

b. In addition to the special order’s effect on current profits, what other longer-term qualitative factors should Lucca’s management consider before any decision to accept the special order opportunity?

Answer 1

a)

Variable cost varies with number of output whereas Fixed cost remains constant within a relevant range .Thus variable cost is always relevant in decision making since it is an incremental cost whereas Fixed cost is irrelevant .

Revenue from special offer (20000*142)		2840000
less:Variable cost
Direct material (20000*80)	1600000
Direct labor (20000*28)	560000
Variable Manufacturing Overhead (20000*22)	440000
Total variable cost		-2600000
Incremental Profit from acceptance of offer		240000

Lucca's operating income will increase by 240000 from acceptance of offer .

**It is mentioned no additional marketing cost will be incurred thus same is avoidable.

b)

other longer-term qualitative factors should Lucca’s management consider before any decision to accept the special order opportunity includes :

1)Whether sales to regular or current customers are affected on acceptance of offer .

2)Whether there is any potential to enter new sales area .

3)whether there is any potential for repeat special offer (whether the offer is for one time or repeatable) and whether customer have god track record in paying terms.