Question

Alert company sells a high quality watch at $750 per unit to specialty stores that provide various watches and auxiliary products. Alert Company is manufacturing and selling 25,000 units of its high quality watch a year using only 80% capacity. The variable cost is $500 per watch and the annual fixed cost is $2,000,000. If Alert Company would reduce its capacity size to the current production level, it could save 15% of the fixed costs. Alert Company was recently contacted by a department store who is willing to buy 6,000 units of the watch at $600 per unit. The Alert's managers strongly believe that the department store intends to sell several high quality watch items at lower prices than the prices charged by specialty stores from now on. Alert Company estimates that there will be 8% cannibalization of existing sales due to the department store's low pricing strategy on watches. Alert Company has to decide whether to accept or reject the department store's proposal.

A. Do you think fixed costs are relevant to this decision? Explain.

B. First, compute the contribution margin on the 8% cannibalized sales. Then, discuss whether or not this amount is relevant to the decision.

C. According to you answers in A and B, decide whether or not Diamond Company should accept the department store's proposal. Show the calculations supporting your conclusion. In the decision and calculation for C, you may want to add your own assumption -- for instance, another potential source of sales cannibalization.

Answer 1

answers-Microsoft Excel Home Insert Page Layout Formulas Data Review View cut 2 AutoSum 11, Aa" ー-= 9-1ョwrap Text General a Copy B I LI , B-6-A, ー ミ涅涅 Merge & Center, s-% , 'd8f8 Conditional Format Cell Insert Delete Format Paste Sort &Find & Format Painter 2 Clear Filter Select Editing Formatting as Table Styles Cells Clipboard Alignment Styles N20 1 A) yes, fixed costs are relevant to this decision. 2 because if we reduce capacity to current level of activity, fixed cost of $300000 will save (2000000x|5%) 3 and if we reduce capacity to current level and accept this special order fixed cost will increase by this $300000 5 B) 8% cannibalized sales means , sales will reduce by 8% 6 | reducation in sales units = 25000 units x 896 : 2000 units 7 sales price per unit 8 less variable cost per unit 9 contribution margin per unit 10 c nits500000 working note- special order contribution margin calculation sales price less variable cost per unit contribution margin per unit 750 500 250 600 500 100 contribution margin of 2000 u 11 there will reduction in contribution margin by $ 500000 if we accept this special order. 12 hence this amount is relevant to the decision 14 C) Incrimental contribution margin by special order 6000 units x 100600000 15 less opportunity cost related to fixed cost 16 less contribution margin loss due to cannibalization 17 net loss on special order 19 as there is loss of $ 200000 if we accept this special order, company should not accept this proposal. 300000 500000 200000 -4 ト 커 Sheet2 Sheet3 Sheet4 SheetS Sheets Sheet? SheetB Sheet9 Sheet10 Sheet1 1 Sheet12 Ready 罷口凹 14296 4:41 AM 09-May-19