Question

Decision on Accepting Additional Business Talladega Tire and Rubber Company has capacity to produce 500,000 tires. Talladega presently produces and sells 400,000 tires for the North American market at a price of $200 per tire. Talladega is evaluating a special order from a European automobile company, Autobahn Motors. Autobahn is offering to buy 100,000 tires for $150 per tire. Talladega's accounting system indicates that the total cost per tire is as follows: Direct materials $75 Direct labor 20 Factory overhead (70% variable) 30 Selling and administrative expenses (60% variable) 18 Total $143 Talladega pays a selling commission equal to 3% of the selling price on North American orders, which is included in the variable portion of the selling and administrative expenses. However, this special order would not have a sales commission. If the order was accepted, the tires would be shipped overseas for an additional shipping cost of $3 per tire. In addition, Autobahn has made the order conditional on receiving European safety certification. Talladega estimates that this certification would cost $400,000. a. Prepare a differential analysis dated July 31 on whether to reject (Alternative 1) or accept (Alternative 2) the special order from Autobahn Motors. If an amount is zero, enter "0". If required, round interim calculations to two decimal places. Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) July 31 Differential Effects Reject Order (Alternative 1) (Alternative 2) (Alternative 2) Аcсеept Order Revenues Costs: Direct materials Direct labor Check My Work Previous 2 more Check My Work uses remaining.

Answer 1

Let's have a comparison of both the alternatives.

Working Note -1

Present sales

No.of tires = 400000 tires

selling price per tire = 200 per tire

Total sales 400000*200= 80,00,000$

Working Note 2

Analysis of variable cost

Direct Material = $75

Direct labour=$20

Variable factory overhead $30 * 70% = $21

Variable selling and administrative expenses $18* 60% = $10.8

Sales commission = 3% of selling price being, $200*3% = $6

Therefore selling expenses without sales commission will be,

$10.8-$6 =$ 4.8

Note: Whether or not the order is accepted, the fixed portion of the cost will remain same.So we are considering only the variable costs and the additional costs , for comparison.

Solution

Amounts are in $

Particulars	Alternative 1 Reject	Alternative 2 - Accept	Differential effects.
No of units	400000	500000	100000
Revenue
Present sales 400000* 200	800,00,000	800,00,000
New order 100000* 150	-	150,00,000
Total Sales (A)	800,00,000	950,00,000	150,00,000
Costs;
Direct Material $75* no of units	300,00,000	375,00,000	75,00,000
Direct Labour $20* no of units	80,00,000	100,00,000	20,00,000
Variable factory overhead (See working note) 21* units	84,00,000	105,00,000	21,00,000
Variable selling overhead (See working note) 4.8* units	19,20,000	24,00,000	480000
Sales commission 6*400000 units.(there is no sales commission for overseas sales)	24,00,000	24,00,000	-
Shipping cost 100000 * $3	-	3,00,000	3,00,000
Certification cost	-	4,00,000	4,00,000
Total cost (B)	507,20000	635,00,000	127,80,000
Profit (A)-(B)	292,80,000	315,00,000	22,20,000

So from the table it is evident that company gets additional profit of $ 22,20000 if the order is accepted.

Therefore it is suggested to accept the order of additional 1,00,000 tires at a selling price of $150 each.

The additional profit can also be calculated using a simple formula.

Incremental sales - incremental cost,

150 - (75+20+21+4.8+3+4) = $22.2/tire × 100000 tires= 22,20000