Question

1. Special Order

Midnight Rambler Co. produces a variety of electric scooters.  Management follows a pricing policy of manufacturing costs plus 60 percent.  In response to request from Jack Flash Cycles, the following price has been developed for an order of 300 scooters (the smallest scooter Midnight Rambler produces:

Manufacturing Costs:

Direct materials: 24,000

Direct Labor: 30,000

Factory Overhead: 36,000

Total: 90,000

markup (60%): 54,000

Selling Price: 144,000

  

Jack Flash rejected this price and offered to purchase the 300 scooters at a price of $120,000.  The following additional information is available:

• Midnight Rambler has sufficient excess capacity to produce the scooters
• Factory overhead is applied ono the basis of direct labor dollars
• Budgeted factory overhead is $800,000 for the current year.  Of this amount, $200,000 is fixed of the $36,000 of factory overhead assigned to Jack Flash Cycles, only $27,000 is driven by special order; $9,000 is a fixed cost.
• Selling and Administrative expenses are budgeted as follows:
  • Fixed………………………………$180,000 per year
  • Variable………………………….$40 per unit manufactured and sold.

Required:

1. The president of Midnight Rambler wants to know if he should allow Jack Flash to have the scooters for $120,000.  Determine the effect on profits from accepting Jack Flash’s offer.
2. Briefly explain why certain costs should be omitted from the analysis in requirement (a.)
3. Assume Midnight Rambler is operating at capacity and could sell the 300 scooters at its regular markup:
   1. Determine the Opportunity Cost of accepting Jack Flash’s offer.
   2. Determine the effect on profits of accepting Jack Flash’s offer
4. What other factors should Midnight Rambler consider before deciding to accept the special order?

Answer 1

Answer is given below

a) $120,000 Evaluation of Special order Sales revenue Less: Variable cost Direct Material Direct Labor Cost driven by special order Variable selling cost Total Variable cost Incremental contribution $24,000 $30,000 $27,000 $12,000 $93,000 $27,000 Since there is incremental contribution the special order should be accepted Effect on Net income is T. $27,000 Increase in income b) Fixed cost should be omitted from analysis since it is sunk cost and not a relevant cost in evaluation of special order Fixed factory overhead and fixed selling and administration overhead is excluded Relevant cost is variable cost and any incremental cost due to special order Opportunity cost of accepting Jack Flash offer Profit on Regular sales $54,000 Effect on profit of accepting special order Profit on Regular sales $54,000 Incremental contribution $27,000 Net effect on profit $27,000 Decrease in income Other factors to be considered by Midnight Rambler - Consumer demand - Capacity utilisation - Price cut affect on market - competitor pricing