I
I. Special order example
Jordan Company budgeted sales of 400,000 calculators at $40 per unit last year. Variable manufacturing costs were budgeted at $16 per unit, and fixed manufacturing costs at $10 per unit. A special order for 40,000 calculators at $23 each was received by Jordan in March. Jordan has sufficient plant capacity to manufacture the additional quantity without incurring any additional fixed manufacturing costs; however, the production would have to be done on an overtime basis at an estimated additional cost of $3 per calculator. Acceptance of the special order would not affect Jordan's normal sales and no selling expenses would be incurred.
A. Should the special order be accepted? (show work to justify recommendation)
Yes – the special order should be accepted because:
1. The selling price exceeds the VC/unit
2. Normal sales are not reduced by taking the special order
3. No additional FC are incurred
VC/unit on special order = $16 + $3 = $19 VC/unit; Revenue = $23/unit; So taking the special order results in an additional $4 CM per unit * 40,000 units = $160,000 additional CM (and profit, since there are no additional FC)
B. What if: In addition to the added $3 VC/unit Jordan also has to acquire a special piece of equipment to fill this order? The equipment cost $100,000 and has no residual value to the company beyond this order. Should the special order be accepted in this case? (show work to justify recommendation)
Yes – the special order should still be accepted, because the $160,000 additional CM (from part A above) covers the additional $100,000 FC and still leaves the firm $60,000 better off.
II. Make or buy example
The Talbot Company makes wheels that it uses in the production of bicycles. Talbot's costs to produce 100,000 wheels annually are:
| |Direct materials |$30,000 |
| |Direct labor |$50,000 |
| |Variable overhead |$20,000 |
| |Fixed overhead |$70,000 |
An outside supplier has offered to sell Talbot similar wheels for $1.25 per wheel. If the wheels are purchased from the outside supplier, $15,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $45,000 per year.
A. Should Talbot make or buy the wheels? (show work to support recommendation)
They should buy the wheels. The TOTAL cost to make versus buy at 100,000 wheels is:
Make: $1.00 (100,000) + $70,000 = $170,000 Cost function to make
Buy: $1.25(100,000) + $55,000 - $45,000 = $135,000 Cost function to buy
B. What is the price per wheel that Talbot could pay to buy the wheels and be indifferent between making or buying them? (show work to support answer)
This is the same as saying: “What ‘buy’ price makes these two cost functions the same?” To solve, set the ‘Buy’ VC as an unknown and solves for the point of indifference:
$1 (100,000) + $70,000 = X (100,000) + $10,000
$170,000 = X 100,000 + $10,000
$160,000 = X 100,000
X = $1.60
$1.60 is the ‘buy’ price that makes the two cost functions the same.
C. Using the original information from A), at what quantity is Talbot indifferent between making and buying wheels?
This is also setting the two cost functions equal to each other, but now the unknown value is the quantity.
$1 (X) + $70,000 = $1.25 X + $10,000
$1 X + $60,000 = $1.25 X
$60,000 = $.25 X
X = 240,000
At 240,000 wheels, the two alternatives cost the same amount in total costs. Above 240,000 total cost to ‘make’ is lower, below 240,000 total cost to buy is lower
D. Graph the alternatives:
[pic]
-----------------------
Unit variable costs:
= .30 DM / unit
= .50 DL / unit
= .20 VOH / unit
= $1.00 VC / unit
Total Cost
Qty - # of wheels
$70,000 FC
$10,000 FC
Total cost - Buy
Total cost - Make
240,000 wheels
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