Question

pecial Order: High-Low Cost Estimation
Autoliv produces air bag systems that it sells to automobile manufacturers throughout the world. Assume the company has a capacity of 50 million units per year, it is currently producing at an annual rate of 40 million units. Autoliv has received an order from a Japanese manufacturer to purchase 100,000 units at $65 each. Budgeted costs for 40 million and 45 million units are as follows:

(in thousands, except costs per unit)	40 Million Units	45 Million Units
Manufacturing costs
Direct materials	$ 560,000	$ 630,000
Direct labor	220,000	247,500
Factory overhead	1,780,000	1,822,500
Total	2,560,000	2,700,000
Selling and administrative	1,120,000	1,125,000
Total	$ 3,680,000	$ 3,825,000
Costs per unit
Manufacturing	$ 64.00	$ 60.00
Selling and administrative	28.00	25.00
Total	$ 92.00	$ 85.00

Sales to auto manufacturers are priced at $120 per unit, but the sales manager believes the company should aggressively seek the Japanese business even if it results in a loss of $20 per unit. She believes obtaining this order would open up several new markets for the company's product. The general manager commented that the company cannot tighten its belt to absorb the $2,000,000 loss ($20 × 100,000) it would incur if the order is accepted.

(a) Determine the financial implications of accepting the order. (Hint: Use the high-low method to determine variable costs per unit.)

Accepting the offer will Answerdecreaseincrease

profits by $Answer

.

(b) How would your analysis differ if the company were operating at capacity? Determine the advantage or disadvantage of accepting the order under full-capacity circumstances.

Use a negative sign with your answer to indicate a net disadvantage, if applicable.

$Answer

Answer 1

(a)

High point	45 million	3,825,000
Low point	40 million	3,680,000
Difference	5 million	145,000

Variable cost per unit:

= 145,000 (thousand) / 5 million

= 29

Financial if the order is accepted:

Unit selling price	65
Unit	(29)
Contribution margin	36
Size of the order	100,000
Financial impact of accepting the order	3,600,000

.

(b) Differential analysis:

Contribution from special order	3,600,000
Opportunity cost {100,000 (120 - 29)}	9,100,000
Net disadvantage of accepting order	5,500,000