Question

Fairmount Travel Gear produces backpacks and sells them to vendors who sell them under their own label. The cost of one of its backpacks follows.

Materials	$	18.40
Labor		12.40
Variable overhead		5.40
Fixed overhead ($2,905,600 per year; 454,000 units per year)		6.40
Total	$	42.60

Riverside Discount Mart, a chain of low-price stores, has asked Fairmount to supply it with 23,000 backpacks for a special promotion Riverside is planning. Riverside has offered to pay Fairmount a unit price of $46 per pack. The regular selling price is $64. The special order would require some modification to the basic model. These modifications would add $4.40 per unit in material cost, $1.90 per unit in labor cost, and $0.90 in variable overhead cost. Although Fairmount has the capacity to produce the 23,000 units without affecting its regular production of 454,000 units, a one-time rental of special testing equipment to meet Riverside’s requirements would be needed. The equipment rental would be $85,800 and would allow Fairmount to test up to 54,000 units.

Required:

a. Prepare a schedule to show the impact of filling the Riverside order on Fairmont’s profits for the year.

b. Do you agree with the decision to accept the special order?

c. Considering only profit, determine the minimum quantity of backpacks in the special order that would make it profitable.

Answer 1

Since there is spare capacity, only incremental costs are relevant for the special order as there will be no loss of regular sales
Schedule
Revenue from special order 23000*46	1,058,000
Costs:
Material 23000*(18.40+4.40)	524,400
Labor 23000*(12.40+1.90)	328,900
Variable Overhead 23000*(5.40+0.90)	144,900
Rent of Equipment	85,800
Total costs	1,084,000
Profit	(26,000)
No, the order should not be accepted since loss
c.Minimum quantity = Increase in fixed costs/Contribution margin per unit
=85,800/(46-22.8-14.3 - 6.3)
= 33,000 Backpacks