Question

Polaski Company manufactures and sells a single product called a Ret. Operating at capacity, the company can produce and sell 42,000 Rets per year. Costs associated with this level of production and sales are given below:

	Unit				Total
Direct materials	$	20			$	840,000
Direct labor		10				420,000
Variable manufacturing overhead		3				126,000
Fixed manufacturing overhead		5				210,000
Variable selling expense		2				84,000
Fixed selling expense		6				252,000
Total cost	$	46			$	1,932,000

The Rets normally sell for $51 each. Fixed manufacturing overhead is $210,000 per year within the range of 32,000 through 42,000 Rets per year.

Required:

1. Assume that due to a recession, Polaski Company expects to sell only 32,000 Rets through regular channels next year. A large retail chain has offered to purchase 10,000 Rets if Polaski is willing to accept a 16% discount off the regular price. There would be no sales commissions on this order; thus, variable selling expenses would be slashed by 75%. However, Polaski Company would have to purchase a special machine to engrave the retail chain’s name on the 10,000 units. This machine would cost $20,000. Polaski Company has no assurance that the retail chain will purchase additional units in the future. What is the financial advantage (disadvantage) of accepting the special order? (Round your intermediate calculations to 2 decimal places.)

2. Refer to the original data. Assume again that Polaski Company expects to sell only 32,000 Rets through regular channels next year. The U.S. Army would like to make a one-time-only purchase of 10,000 Rets. The Army would pay a fixed fee of $1.60 per Ret, and it would reimburse Polaski Company for all costs of production (variable and fixed) associated with the units. Because the army would pick up the Rets with its own trucks, there would be no variable selling expenses associated with this order. What is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

3. Assume the same situation as described in (2) above, except that the company expects to sell 42,000 Rets through regular channels next year. Thus, accepting the U.S. Army’s order would require giving up regular sales of 10,000 Rets. Given this new information, what is the financial advantage (disadvantage) of accepting the U.S. Army's special order?

	1. 2. 3.

Answer 1

1	Unit	Total—
		10,000 units
Sales from the order ($51 × 84%)	$42.84	$428,400
Less costs associated with the order:
Direct materials	20	200,000
Direct labor	10	100,000
Variable manufacturing overhead	3	30,000
Variable selling expense ($2 × 25%)	0.5	5,000
Special machine ($20,000 ÷ 10,000 units)	2	20,000
Total costs	33.5	355,000
Net increase in profits	$9.34	$73,400
2. Sales from the order:
Reimbursement for costs of production (variable production costs of $33 plus fixed manufacturing overhead cost of $5 = $38 per unit; $38 per unit × 10,000 units)	$380,000
Fixed fee ($1.60 per unit × 10,000 units)	$16,000
Total revenue	$396,000
Less incremental costs—variable production costs
($33 per unit × 10,000 units)	$330,000
Net increase in profits	$66,000
3. Sales:
From the US Army (above)	$396,000
From regular channels ($51 per unit × 10,000 units)	$510,000
Net decrease in revenue	($114,000)
Less variable selling expenses avoided if the Army’s
order is accepted ($2 per unit × 10,000 units)	$20,000
Net decrease in profits if the Army’s order is accepted	($94,000)