Question

Davis Kitchen Supply produces stoves for commercial kitchens. The costs to manufacture and market the stoves at the company's normal volume of 6,000 units per month are shown in the following table

Unit manufacturing costs
Variable materials	$	51
Variable labor		76
Variable overhead		26
Fixed overhead		61
Total unit manufacturing costs				$	214
Unit marketing costs
Variable		26
Fixed		71
Total unit marketing costs					97
Total unit costs				$	311

Unless otherwise stated, assume that no connection exists between the situation described in each question; each is independent. Unless otherwise stated, assume a regular selling price of $372 per unit. Ignore income taxes and other costs that are not mentioned in the table or in the question itself.

Required:

a. Market research estimates that volume could be increased to 7,000 units, which is well within production capacity limitations if the price were cut from $372 to $327 per unit. Assuming that the cost behavior patterns implied by the data in the table are correct.

a-1. What would be the impact on monthly sales, costs, and income?

a-2. Would you recommend taking this action?

b. On March 1, the federal government offers Davis a contract to supply 1,000 units to military bases for a March 31 delivery. Because of an unusually large number of rush orders from its regular customers, Davis plans to produce 8,000 units during March, which will use all available capacity. If it accepts the government order, it would lose 1,000 units normally sold to regular customers to a competitor. The government contract would reimburse its "share of March manufacturing costs" plus pay a $49,000 fixed fee (profit). (No variable marketing costs would be incurred on the government's units.) Assuming that the government's "share of March manufacturing costs" will be the proportionate fixed manufacturing cost, what impact would accepting the government contract have on March income?

c. Davis has an opportunity to enter a highly competitive foreign market. An attraction of the foreign market is that its demand is greatest when the domestic market's demand is quite low; thus, idle production facilities could be used without affecting domestic business. An order for 2,000 units is being sought at a below-normal price to enter this market. For this order, shipping costs will total $41 per unit; total (marketing) costs to obtain the contract will be $6,000. No other variable marketing costs would be required on this order, and it would not affect domestic business. What is the minimum unit price that Davis should consider for this order of 2,000 units?

d. An inventory of 460 units of an obsolete model of the stove remains in the stockroom. These must be sold through regular channels (thus incurring variable marketing costs) at reduced prices or the inventory will soon be valueless. What is the minimum acceptable selling price for these units?

e-1. A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. Davis’s plant would operate at two-thirds of its normal level, and total fixed manufacturing costs would be cut by 25 percent. What in-house unit cost should be used to compare with the quotation received from the supplier? Assume the payment to the outside contractor is $216.
e-2. Should the proposal be accepted for a price (that is, payment to the outside contractor) of $216 per unit?

f-1. A proposal is received from an outside contractor who will make and ship 2,000 stoves per month directly to Davis’s customers as orders are received from Davis’s sales force. Davis’s fixed marketing costs would be unaffected, but its variable marketing costs would be cut by 20 percent for these 2,000 units produced by the contractor. The idle facilities would be used to produce 1,600 modified stoves per month for use in extreme climates. These modified stoves could be sold for $451 each, while the costs of production would be $276 per unit variable manufacturing expense. Variable marketing costs would be $51 per unit. Fixed marketing and manufacturing costs would be unchanged whether the original 6,000 regular stoves were manufactured or the mix of 4,000 regular stoves plus 1,600 modified stoves were produced. What in-house unit cost should be used to compare with the quotation received from the outside contractor? Assume the payment to the outside contractor is $216.

f-2. Should the proposal be accepted for a price of $216 per unit to the outside contractor?

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	Before Price Reduction After Price Reduction Impact Sales price Quantity Revenue Variable manufacturing costs Variable marketing costs Contribution margin Fixed manufacturing costs Fixed marketing costs Income

Market research estimates that volume could be increased to 7,000 units, which is well within production capacity limitations if the price were cut from $372 to $327 per unit. Assuming that the cost behavior patterns implied by the data in the table are correct.

A2. Would you recommend taking this action? Yes or no?

Answer 1