Steve Murningham, manager of an electronics division, was considering an offer by Pat Sellers, manager of a sister division. Pat's division was operating below capacity and had just been given an opportunity to produce 8,000 units of one of its products for a customer in a market not normally served. The opportunity involves a product that uses an electrical component produced by Steve's division. Each unit that Pat's department produces requires two of the components. However, the price the customer is willing to pay is well below the price usually charged; to make a reasonable profit on the order, Pat needs a price concession from Steve's division. Pat has offered to pay full manufacturing costs for the parts. So that Steve would know that everything was above-board, Pat had supplied the following unit-cost and price information concerning the special order, excluding the cost of the electrical component:
Selling price $ 32
Less costs:
Direct materials (17)
Direct labour (7)
Variable overhead (2)
Fixed overhead (3)
Operating profit $ 3
The normal selling price of the electrical component is $2.30 per unit. Its full manufacturing cost is $1.85 ($1.05 variable and $0.80 fixed). Pat had argued that paying $2.30 per component would wipe out the operating profit and result in her division showing a loss. Steve was interested in the offer because his division was also operating below capacity (the order would not use all the excess capacity).
Required:
1.Should Steve accept the order at the selling price of $1.85 per unit? Calculate the amount by which his division's profits be changed if the order is accepted? Calculate the amount by which the profits of Pat's division will change if Steve agrees to supply the part at full cost?
2.Suppose, Steve offers to supply the component at $2. In offering this price, Steve states that it is a firm offer not subject to negotiation. Should Pat accept this price and produce the special order? Use calculation to support your answer. If Pat accepts the price, calculate the amount by which the profits for Steve's division will change? (5 marks)
3.Assume that Steve's division is operating at full capacity and that Steve refuses to supply the part for less than the full price. Should Pat still accept the special order? Explain, showing all calculations.