Question

Huang Automotive is presently operating at 75% of capacity. The company recently received an offer from a Korean truck manufacturer to purchase 21,500 units of a power steering system component for $198 per unit. Peter Wu, vice-president of sales, notes that although there will be an additional $2.25 shipping cost for each component, he thinks that accepting the order will get the company's "foot in the door" of an expanding international market.

To determine variable and fixed costs, Huang's accountant used the high-low method with the following production and cost information for the last two years:

	202,000 units	220,000 units
Direct material costs	$17,069,000	$18,590,000
Direct labor costs	5,353,000	5,830,000
Overhead costs	23,706,000	24,660,000
Selling and administrative costs	12,022,000	12,220,000
Total costs	$58,150,000	$61,300,000
Total costs per unit	$287.87	$278.64

T.J. Chan, vice-president of engineering, feels that any new market should first show its profitability and that the $198 per unit offer is not only below the regular $250 selling price, but it's below the unit cost of the component. She also points out that there will be additional setup costs of $250,000 and that Huang will have to lease some special equipment for $290,000.

1. Using the high-low method to determine cost behavior, what would the expected profit be on the special order (use a negative sign for a loss)?

Please explain every step including the high-low method

Answer 1

Units	202,000	220,000
Direct material	17,069,000	18,590,000
Direct Labor	5,353,000	5,830,000
Overhead costs	23,706,000	24,660,000
Selling and Admin cost	12,022,000	12,220,000
Total cost	58,150,000	61,300,000
Using high low method, variable cost per unit = Difference in Cost/Difference in Volume
Overhead	53	per unit
Selling and Admin Cost	11	per unit
Direct material and direct labor are variable costs
Since there is spare capacity, only incremental costs are relevant for the special order
Calculation of profit from special order:
Revenue	4257000
Less: costs
Direct material	1,816,750
Direct Labor	569750
Overhead costs	1,139,500
Selling and Admin cost	236,500
Shipping cost	48,375
Setup costs	250,000
Lease cost	290,000
Total cost	4,350,875
Profit from special order	-93,875
Should not be accepted

9 Using high low method, variable cost per unit = Difference in Cost/Difference in Volume 10 Overhead =(C5-B5)/(C2-B2) per unit 11 Selling and Admin Cost 1=(C6-B6)/(C2-B2) per unit 12 13 Direct material and direct labor are variable costs 14 Since there is spare capacity, only incremental costs are relevant for the special order 15 16 Calculation of profit from special order: 17 Revenue =21500*198 18 Less: costs 19 Direct material =21500* B3/B2 20 Direct Labor =21500*B4/B2 21 Overhead costs =B10*21500 22 Selling and Admin cost =B11*21500 23 Shipping cost =21500*2.25 24 Setup costs 250000 25 Lease cost 290000 26 Total cost =SUM(B19:B25) 27 Profit from special order =B17-B26 28 Should not be accepted