Question

Ovation Company has a single product called a Bit. The company normally produces and sells 43,200 Bits each year at a selling price of $38 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	10.50
Direct labour		4.80
Variable manufacturing overhead		3.60
Fixed manufacturing overhead		2.70	($116,640 total)
Variable selling expenses		3.90
Fixed selling expenses		2.40	($103,680 total)
Total cost per unit	$	27.90

     A number of questions relating to the production and sale of Bits follow. Each question is independent.

Required:
1. Assume that Ovation Company has sufficient capacity to produce 64,800 Bits each year without any increase in fixed manufacturing overhead costs. The company could increase its sales by 25% above the current 43,200 units each year if it were willing to increase the fixed selling expenses by $78,000.

a. Calculate the incremental net operating income.

b. Would the increased fixed selling expenses be justified?

• Yes

• No

2. Assume again that Ovation Company has sufficient capacity to produce 64,800 Bits each year. A customer in a foreign market wants to purchase 10,800 Bits. Import duties on the Bits would be $1.70 per unit, and costs for permits and licences would be $4,860. Both import duties and permits and licenses will be paid by Ovation. The only selling costs that would be associated with the order are $2.40 per unit shipping cost. Compute the per unit break-even price on this order. (Do not round your intermediate calculations. Round your answer to 2 decimal places.)

3. The company has 1,000 Bits on hand that have some irregularities and are therefore considered to be “seconds.” Due to the irregularities, it will be impossible to sell these units at the normal price through regular distribution channels. What unit cost figure is relevant for setting a minimum selling price? (Round your answer to 2 decimal places.)

4. Due to a strike in its supplier’s plant, Ovation Company is unable to purchase more material for the production of Bits. The strike is expected to last for two months. Ovation Company has enough material on hand to operate at 30% of normal levels for the two-month period. As an alternative, Ovation could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 60% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20%. What would be the impact on profits of closing the plant for the two-month period? (Input the amount as a positive value. Do not round your intermediate calculations.)

5. An outside manufacturer has offered to produce Bits and ship them directly to Ovation’s customers. If Ovation Company accepts this offer, the facilities that it uses to produce Bits would be idle; however, fixed manufacturing overhead costs would be reduced by 70%. Since the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their current amount. Compute the unit cost that is relevant for comparison to the price quoted by the outside manufacturer. (Do not round your intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

1
Selling price per unit	$38.00
Variable price per unit (10.50+4.80+3.60+3.90)	$22.80
Contribution margin	$15.20
a.
Calculation of incremental operating income
Increase in sales revenue (43200*25%)	$10,800
Increase in contribution margin (10800*15.20)	$164,160
Less: Additional fixed selling expenses	$78,000
Incremental operating income	$86,160
b.
Yes, since this will result in positive incremental operating income, the increased fixed selling expenses is justified
2
Calculation of unit break even price
Variable manufacturing cost per unit (10.50+4.80+3.60)	$18.90
Import duties per unit	$1.70
Costs for permit and license (4860/10800)	$0.45
Shipping cost per unit	$2.40
Unit break even price	$23.45
The company should sell the product to the foreign customer for atleast $23.45. Any price charged below $23.45 will result in loss for the company
3
Company has 1,000 bits on hand which have certain irregularities and these bits have already been produced.
Therefore the production costs incurred is a sunk costs as already they have been incurred. Also the fixed selling price being period costs would still be incurred even if the units are not sold.
The only relevant costs would therefore be the variable selling expense of $3.90.
Company should therefore set the minimum selling price of $3.90 for the 1,000 defective bits.
4
Calculation of operating income when the factory is closed for 2 months
Loss in contribution margin (43200*2/12*15.20*30%)	-$32,832.00
Avoidable fixed costs
Fixed manufacturing costs (116640*40%*2/12)	$7,762.67
Fixed selling expense (103680*20%*2/12)	$3,456.00
Operating loss on closure of factory	-$21,613.33
The operating income would reduce by $21,633.33 if factory is closed down for 2 months.
5
Savings in variable manufacturing costs	$18.90	(10.50+4.80+3.60)
Reduction in fixed manufacturing costs	$1.89	(116640*70%)/43200
Reduction in variable sellings costs	$1.30	3.90/3
Total savings in costs	$22.09
The unit selling price relevant for comparison to the price quoted by the outside manufacturer is $22.09.
Purchase price offered below $22.09 should be accepted.